Bears Unwinding Positions Leaves Rallying Stocks Exposed

The extreme pessimism that’s gripped American stock investors for much of the year is starting to dissipate. That might be reason for caution.

Stock bulls betting the whiff of recession means the worst of the Federal Reserve’s rate-hike medicine has been administered drove the S&P 500 to a second day of gains and the highest level in almost two months.

The rally, and attendant change in sentiment, has forced speculators to unwind bearish positions that once served as a key source of demand when stocks bounced back. With short sellers retreating, stocks might be exposed to a downdraft if the Fed turns more aggressive on future rate increases or corporate profits start to crater.

“Dour sentiment in mid-June was a great contrarian set up for this rally, but that can now be less relied upon with the pivot since, however modest,” said Peter Boockvar, chief investment officer at Bleakley Advisory Group.