The new Trump administration is coming in hot mass deportations of undocumented immigrants and the threats to launch a global trade war among the immediate priorities. The fighting continues Europe and the Middle East. And bond traders are scaling back their bets on lower interest rates as the US economy looms new wave of inflation.
But despite all these risks, investors are undeterred, as the S&P 500 Index set another record high this week. Traders are piling into the riskiest parts of the market as the small-cap Russell 2000 Index has nearly doubled the performance of the S&P 500 over the past two weeks and is approaching its first record high since 2021. Meanwhile, the Cboe Volatility Index is at that level. historically they represent a calmness between merchants.
This level of optimism in the face of these broader concerns is surprising even to some Wall Street professionals. For them, it is also a cause for alarm.
“One of my main concerns is extreme bullishness, and we’re seeing signs of that,” said Eric Diton, president and managing director of Wealth Alliance. “We know from history that when investors are very bullish and everyone is in the market, the question is, who buys to go up?”
With the S&P 500 hitting a record 53 times this year, or roughly every five days, high optimism is hardly new to the stock market. However, signs of vitality are beginning to appear.
Wall Street forecasters expect another year of double-digit gains after the S&P 500 posted more than 20% gains in 2023 and 2024. The index has only once given such a rally, during the dot-com bubble. Family shares because it’s a record share of all assets – and a percentage of Americans, too Stocks are expected to rise in the next 12 months. The data Bank of America show that retail customers have a large share of their investments in stocks and are taking more risks.
“Investors seem to be rejecting almost any risk-averse strategy,” Richard Bernstein Advisors wrote in a note to clients this week.
Muddy Outlook
The push for equity risk has recently been concentrated in small caps. Since Donald Trump’s victory, the group — a laggard for most of the year — has caught up with the broader market, now up 20% in 2024, compared with the S&P 500’s 26% advance. The group is expected to benefit from the new administration’s protectionist trade tactics as they have less exposure to international markets.
The thing is, while there is some logic to the small cap rally based on the incoming administration’s “America First” agenda, that’s not the whole story. The group’s earnings outlook is not great, and there is growing uncertainty about how Trump’s plans will affect economic growth, inflation and the path of central bank interest rates.
Small businesses are particularly sensitive to monetary policy because they rely on debt financing. And the Federal Reserve has stated that the expected pace of future rate cuts is slowing. That may not be the ideal backdrop for small caps, which are considered the riskiest corners of the market.
“In trader talk, it looks like a team today, but not a marriageable one,” said Steve Sosnick, chief strategist at Interactive Brokers.
Other fault lines are also opening up in the market. Semiconductor stocks, which have led U.S. stocks for the past two years, are under scrutiny. The fervor for all things artificial intelligence that fueled much of their rally is beginning to subside. Meanwhile, chipmakers will be on the front lines of any trade war, given the global nature of their supply chain.
“While tech remains near the top of the year-to-date rankings, it has been near the bottom for the past three months,” Jonathan Krinsky, BTIG’s chief market technician, wrote in a note to clients. “The bulls really need to see the halves stabilize here in 2025 to avoid a bigger breakdown.”
Keeping the faith
That said, optimists still see plenty of reasons to keep the faith. They represent a healthy expansion of market leadership as stocks in industries other than tech or AI are gradually taking over. And the ratings, although extended, are not quite at the highest levels. While the S&P 500’s 10-year yield has risen sharply, it’s not yet at the point where investors might want to jump ship, according to Bloomberg’s Cameron Crise.
Then there’s the hope that the Trump administration’s plans for lower corporate taxes, looser regulations and a softer stance on antitrust policies will more than offset the headwinds. The bulls also take confidence from Trump’s own penchant for using the stock market as a marker for his success. from Wall Street eager The reaction to Trump’s choice of Treasury Secretary Scott Bessent was based on the idea that he was standing in the way of the administration’s aggressive trade and economic proposals.
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Another factor that may be driving enthusiasm for stocks is investors’ memories of what they did during Trump’s previous term, and the belief that it will happen again, despite the differences between 2016 and 2024.
“People’s experience with the stock market during Trump’s last term skews what to expect in this frothy market,” said Alex Atanasiu, portfolio manager at Glenmede Investment Management. “At that time, the market was recovering, and this time the valuations are even higher, we have had two strong years and it is dangerous to think that the market has the same legs.”
All together, these factors can fuel a sense of euphoria and keep the rally alive for a while, whether it’s rational or not. The advice from market professionals is simple: be careful at these levels and read the tea leaves carefully.
“Anyone who thinks we’re not in a highly speculative period, if not in a bubble, isn’t paying attention,” said Richard Bernstein, chief investment officer and founder of Richard Bernstein Advisors. “Look at cryptography. There’s nothing fundamental going on there.”
