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Have the bulls gone too far?

A Santa Claus rally of epic proportions is underway as stocks continue to melt higher in the wake of last week's surprise "taper on" decision from the Federal Reserve. After months of teeth gnashing over the prospect of a slowdown in the pace of the Fed's monthly bond buying stimulus, and with many on Wall Street not looking for a taper decision until January or March, what looked to be a negative surprise has unleashed a torrent of buying.

After bouncing on its 50-day moving average, the S&P 500 has gone on gain 4.1 percent in a matter of days, pushing to new record highs in the process.

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The apparent catalyst is the belief that the Fed's actions reflect confidence in the strength of the economy and the pace of job creation. That may be true. Although it's unknown whether the housing market and consumers will be able to tolerate the increase in long-term interest rates that has accompanied the tapering move, with the 10-year Treasury yield pushing towards the psychologically important 3 percent level that hasn't been seen since mid-2011. 

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 Some housing measures have already softened. And consumers dipped heavily into their savings accounts to fund holiday purchases, with the personal savings rate falling to 4.2 percent in November -- its lowest level in nine months.

But more importantly, gauges of investor sentiment, positioning, and market breadth suggest that caution is warranted.

The gap between bullish and bearish respondents to the Investors Intelligence survey has blown out to levels not seen since 1987 -- exceeding peaks seen during the dot.com and housing bubbles. Just 14 percent of respondents are bearish, while nearly 60 percent are bullish.

The survey results from the National Association of Active Investment Managers is similarly extended, with respondents having spent most of the fourth quarter maintaining a long position that exceeded what they maintained during the entire 2007 market topping event.

There's more.

Cash sitting in money market funds has dropped so low, as folks have piled into stocks, that it can now buy less than 3 percent of the U.S. stock market. According to Jason Goepfert at SentimenTrader, that's the lowest level in 30 years and is a far cry from the 12.3 percent seen during the financial crisis.

And despite all the excitement, fewer and fewer stocks have been participating in the current rally in a sign that buyers are becoming exhausted. On Thursday, during mid-day trading there were just 287 net advancing issues on the NYSE. That's down 72 percent from Tuesday's pre-holiday session and is down from the 2,000+ net advancing issue rally days we saw back in October.

Add it all up, and the evidence is building that this year-end flurry in stocks should encourage caution, not callous overconfidence.

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