By Saqib Iqbal Ahmed
NEW YORK, April 16 (Reuters) - U.S. stocks have rebounded to record highs after the Iran war-driven selloff and there are signs under the market's surface that suggest the rally has further to run.
The market's big recovery even as the U.S-Iran conflict remains in flux and higher energy prices linger has ignited a debate about market froth. Still, there are multiple indicators from bullish options positioning to buying from volatility-linked funds that indicate that the rally's
momentum could continue.
"We've seen a really strong upward thrust for the S&P 500 over the last two weeks," Sonu Varghese, global macro strategist at Carson Group, said.
"Momentum begets momentum, and new highs are a sign of momentum," Varghese said.
Buying from hedge funds and high frequency trading firms are giving some optimism.
"First, there was overwhelming pessimism and conservative positioning among institutional investors," said Mark Hackett, chief market strategist at Nationwide, said noting that some of that has reversed.
Meanwhile, volatility-linked funds, which hemorrhaged stocks in March as markets turned more choppy after the start of the U.S.-Iran war, have turned net buyers, providing further support to the market. One class of these funds - commodity trading advisors (CTAs) - are taking the lead with about $20 billion in equities bought in the past week alone, according to Nomura. Separately, levered ETFs have bought another $27.5 billion over the past week, Nomura estimates.
"Systematic positioning in U.S. equities still remains historically light — there is still room to rebuild before it becomes a source of instability," Nomura cross-asset and equity derivatives strategist Joanna Wang said.
The new high itself could also draw more discretionary buyers to the market.
"When they see the market go up and approach new highs, they buy more because of the fear of missing out," Todd Morgan, chairman of Bel Air Investment Advisors, said.
In another sign of investor enthusiasm, shares of Allbirds , surged more than five-fold on Wednesday after the footwear maker said it was raising capital and pivoting towards an AI computing infrastructure.
CHASING UPSIDE IN OPTIONS
While index level prices are about unchanged from late January, positioning and sentiment have changed materially.
"There was a dramatic reset in positioning in March," Chris Murphy, co-head of derivative strategy at Susquehanna Financial Group, said, noting investors entered April under-owning the market.
"That is why we are seeing such a violent chase," he said, referring to recent aggressive bullish options flows.
That's led to a sharp swing in call skew, a measure of the premium investors pay for upside bets. Three-month 25 delta call skew, normalized by the at-the-money volatility, has gone from being the most defensive in nearly three years to the most bullish in 3-months in the space of three weeks.
"Historically, geopolitical conflicts have had sharp but short-lived effects on equity markets," Garrett DeSimone, head quantitative analyst at OptionMetrics, said.
"This is consistent with equity implied volatility and skew normalizing even as the underlying conflict persists, as the market shifts to pricing resolution," DeSimone said.
NO BULL TRAP HERE
History too favors stock bulls.
Since 1957, when the S&P 500 has logged a fresh record after recovering from a pullback of 5% to 10%, it has tended to extend those gains over the subsequent two weeks to one month, a Reuters analysis of LSEG data showed.
Two weeks after such a recovery, the S&P 500 has posted a median return of 0.66%, with gains widening to 1.01% one month later — broadly in line with median forward returns for any comparable period since 1957, suggesting stocks have historically built on momentum rather than stalled at new highs.
For investors wary of a bull trap — where a declining asset appears to reverse higher, luring in buyers, only to resume its downward trend — the historical record is reassuring.
In roughly two-thirds of the 38 instances when the S&P 500 overcame a 5%-9.9% pullback, stocks were higher two weeks and one month later.
Even in the one-third of cases where stocks faltered, the retreats were relatively contained, with median declines of 1.46% and 3.38% at the two-week and one-month marks, respectively.
Notably, stocks have never fallen back below the recent low within two weeks to a month of the recovery, data showed.
But even with supporting data, not everything about the market makes sense.
"If I told you at the end of February that by mid-April oil futures would be $30 higher, bond yields would be about 35 basis points higher, expectations for two rate cuts would evaporate, and consumer sentiment would be at record lows, would you have reasonably expected major equity indices to be flirting with all-time highs by the end of that timespan?," Steve Sosnick, chief strategist at Interactive Brokers, asked.
"I'm pretty sure that's a 'no,' ... (but) when momentum rules, fundamentals are optional," Sosnick said.
(Reporting by Saqib Iqbal Ahmed; Additional reporting by Laura Matthews; editing by Megan Davies and Anna Driver)
