Thursday, December 26, 2024

Trump’s Plans Risk Inflating Bullish Stock Market Into a Bubble

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(Bloomberg) — The new Trump administration is coming in hot, with mass deportations of undocumented immigrants and threats of triggering a global trade war among its immediate priorities. Fighting continues in Europe and the Middle East. And bond traders are scaling back bets on lower interest rates as the US economy risks a fresh bout of inflation.

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But despite all of these risks, investors seem largely unperturbed, with the S&P 500 Index setting another record just this week. Traders are piling into the riskiest parts of the market, too, with the small-capitalization Russell 2000 Index nearly doubling the S&P 500’s performance over the past two weeks and approaching its first record since 2021. Meanwhile, the Cboe Volatility Index is at levels that historically indicate serenity among traders.

This degree of optimism in the face of those wider concerns is surprising even some Wall Street pros. To them, it’s also a cause for alarm.

“One of my top concerns is extreme bullishness, and we are seeing signs of that,” said Eric Diton, president and managing director of the Wealth Alliance. “We know from history that when investors are too bullish, and everyone is in the market, the question is who is buying to drive it higher?”

With the S&P 500 clocking 53 records this year — or about one every five days — rampant optimism in the stock market is hardly new. Still, signs of exuberance are starting to appear.

Wall Street’s soothsayers expect another year of double-digit gains after the S&P 500 posted back-to-back advances of over 20% in 2023 and 2024. The index has delivered such a rally only once, during the dot-com bubble. Households’ equity holdings as a share of total assets are at a record — and so is a percentage of Americans expecting stocks to rise in the next 12 months. Data from Bank of America show retail clients have a high chunk of their investments in equities and are taking on more risk.

“Investors seem to be shunning virtually any risk-averse strategy,” Richard Bernstein Advisors wrote in a note to clients this week.

Muddy Outlook

Risk-on momentum in equities has lately been concentrated in small caps. Since Donald Trump’s victory, the group — a laggard for most of the year — has caught up in a hurry with the broader market, and is 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 because they’re least exposed to international markets.

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