Momentum trading activity in US stock markets continues to intensify. Fueled by multiple tailwinds, the chase for gains has spread across various asset classes, including junk bonds and cryptocurrencies, prompting warnings from Wall Street. On Friday, the S&P 500 index reached a new all-time high, and the Philadelphia Semiconductor Index surged 11% over five trading days, marking the sixth consecutive week of gains for US stocks.

This week, signs of easing tensions with Iran, stronger-than-expected US employment data, and another significant rally in AI chip stocks combined to push the already overheated momentum trade to new heights. Momentum indices experienced notable volatility but ultimately closed higher.

Although approximately 85% of S&P 500 constituents have reported earnings that beat expectations this quarter, providing fundamental support for the rally, some investors caution that this trade is fragile in the short term, with rotation risks accumulating. Barclays strategists warned that momentum has reached extreme levels historically associated with subsequent sell-offs. Goldman Sachs' trading desk also noted this week that valuations for high-momentum stocks appear stretched, with positioning at multi-year highs.

Momentum Trade Spreads Across Assets, Led by AI Chip Surge

The logic behind momentum trading is straightforward: buy assets with the strongest recent performance and sell the weakest. This strategy proved applicable to nearly all asset classes this week. Junk bonds, cryptocurrencies, and semiconductor stocks were all swept into the same "risk-on" narrative. The chip sector stood out, with AMD's weekly Relative Strength Index (RSI) approaching historically extreme overbought levels.

The software sector also rallied for a fourth consecutive week, gaining over 5%, following a significant decline earlier in the year.

Options market data shows that as US stocks repeatedly hit new highs, traders are pouring into call options with near-record enthusiasm. The volume of call options traded in the single-stock options market exceeded that of put options by a margin not seen in about four years.

Barclays' Euphoria Indicator suggests persistently elevated bullish sentiment among retail investors, with its one-month moving average around 14.3%, nearly three standard deviations above its long-term average. This exuberant trading environment reminds analysts of "late-cycle excess optimism." Greg Boutle, Head of US Equity and Derivatives Strategy at BNP Paribas, noted the current climate "is starting to feel a bit like the late 1990s."

Mechanical Chase Raises Questions About Rally Quality

The market's internal structure reveals another side of this rally. Bloomberg analysis indicates the rebound has a distinct mechanical character. Initially, institutional investors were under-positioned during the early stages of the Iran-Israel conflict. As prices rose and volatility fell, forced buying to cover positions created a positive feedback loop—higher prices, lower volatility, and greater demand for call options, repeating the cycle. However, market breadth continues to deteriorate. The advance relies increasingly on mega-cap tech stocks, semiconductors, and AI-related names, with contributions from other components shrinking. The value factor turned negative after a strong first quarter, the low-volatility factor declined for a sixth consecutive month, and the quality factor (favoring companies with strong profitability and low leverage) remains under pressure. Its 60-day correlation with the momentum factor is near a one-year low. This pattern is characteristic of a risk-on rotation, where defensive factors recede relative to surging speculative ones. Regarding chip stock valuations, while the forward price-to-earnings ratio (24.4x) remains below its 2024 peak of 30.4x, the current price-to-sales ratio is at a historical high.

Barclays and Goldman Sachs Issue Dual Warnings: Valuations and Positioning at Extremes

Despite the sharp rally, warning signals are emerging at the institutional level. Alexander Altmann, Head of Global Equity Tactical Strategy at Barclays, stated in a report this week that investors are flooding into winner stocks. This phenomenon has historically preceded momentum factor breakdowns, as seen during the 2008 Global Financial Crisis and following the announcement of COVID-19 vaccines in 2020. He warned that the current momentum surge has reached extreme levels that have historically signaled pullbacks. Proprietary data from Goldman Sachs similarly shows stretched valuations for high-momentum stocks, with institutional positioning at elevated multi-year levels. Michael Romano, Head of Hedge Fund Equity Derivatives Sales at UBS Securities, noted that AI winner stocks have rallied over 50% from their March lows, stating, "The momentum factor feels very fragile in the near term," and suggested:

Consider hedging AI winner positions by holding short-dated downside protection.

Thursday's market action provided a brief preview: news of renewed US-Iran tensions briefly hammered leading AI stocks, with the momentum index posting its worst single-day performance in three months. However, these losses were quickly recovered on Friday.