The core underlying logic supporting the current stock market has not collapsed. While US stocks hit new all-time highs again this week, Goldman Sachs observes rare technical and sentiment signals emerging beneath the market frenzy, suggesting overcrowded trades and elevated market confidence may harbor risks of a near-term pullback. On the other hand, the core supportive logic for the current market remains intact, with corporate earnings becoming the dominant driver of the rally, US economic resilience exceeding expectations, and conditions for a complete reversal of the uptrend not yet in place.
Market sentiment is excessively exuberant. Goldman Sachs recently noted in a report that the current combination of high market risk appetite alongside strengthening equity momentum is a scenario not seen since 2000. The Goldman Sachs Risk Appetite Indicator, compiled from high-frequency data across five categories—fixed income, equities, liquidity, commodities, and credit—measures overall market risk appetite. A significant decline in this index often signals excessive market pessimism, typically followed by a rebound. This week, the index rose to 1.1, surpassing levels seen at the start of the year and reaching its highest point since 2021. According to Goldman Sachs, since 1950, the index has spent only 2% of the time above 1, placing it at historically extreme highs.
More critically, this high risk appetite coincides with a rapid acceleration in momentum trading in US stocks. The US momentum factor ETF has surged 33% from its March 30 low, compared to an 18.25% gain for the S&P 500 over the same period, pushing the momentum Z-score for US stocks above 3. The Z-score measures the deviation of price from its historical average; a higher value indicates a more extreme deviation from the norm. Goldman Sachs states that it is rare for both risk appetite and momentum to be at such elevated historical levels simultaneously.
Notably, many investors are making highly leveraged bets on chip stocks, with the Philadelphia Semiconductor Index rising nearly 60% since the second quarter. Goldman Sachs' trading desk has observed that retail investor logic has shifted from traditional buy-the-dip strategies to chasing the hot rally, even piling into riskier leveraged trades on semiconductor stocks. Goldman Sachs data shows retail participation in the Direxion Daily Semiconductor Bear 3X Shares ETF and the Direxion Daily Semiconductor Bull 3X Shares ETF has reached the 97th and 99th percentiles, respectively, over the past five years. "Retail investors are entering leveraged sector index products in large volumes. We believe sustained thematic trading heat will foster more pronounced structural volatility beneath the surface," the report noted.
Within the S&P 500, it is exceedingly rare for a single sector to reach a weight of 15% or more. The semiconductor sector has now achieved this, highlighting that the current broad market rally is largely driven by artificial intelligence (AI)-related trading. However, historical precedent suggests investors chasing semiconductor stocks at or near peak valuations often face significant subsequent drawdowns. Research firm Strategas notes that since 1990, very few sectors have reached such a high concentration level in the index. Historical examples include technology hardware during the dot-com bubble, energy stocks around the financial crisis, and the software sector in the late 2010s.
The S&P 500 uses a market-capitalization-weighted methodology, meaning larger companies exert a stronger influence on the index's movement. As chip giants and other AI-related stocks have soared, their index weights have climbed correspondingly. This implies that even ordinary investors holding only S&P 500 index funds have portfolios heavily concentrated in a few narrow, crowded themes, making them highly susceptible to the fortunes of the semiconductor sector. Extreme concentration has propelled the index higher, but once the chip rally cools, the overall market's risk resilience could weaken significantly. Todd Sohn, ETF Strategist at Strategas Securities, stated, "All signs point to this AI-driven rally having reached an extreme zone."
What lies ahead for the market? Goldman Sachs writes that historical exceptions exist: during the 1999 and 2021 rallies, after both indicators rose simultaneously, the stock market continued to rise for nearly 12 more months before peaking. Analysts emphasize that high risk appetite coupled with strong momentum, like high valuations, cannot precisely pinpoint a market top. The core supportive logic for the current market has not collapsed: corporate earnings are the dominant market force, with strong profits supporting valuations; the macroeconomic backdrop is also favorable, with US economic resilience exceeding expectations and financial conditions easing. This Wall Street bank has lowered its probability of a US recession within the next 12 months to 25%. Only a clear deterioration in fundamentals and a complete reversal of the market's uptrend would establish a definitive bearish outlook.
Morgan Stanley is also bullish on equities, with its optimism primarily based on the view that multiple factors are currently pushing US stocks higher, any pullback will be limited, and the overall market uptrend remains intact. The firm's star strategist, Mike Wilson, listed the following driving factors: strong earnings growth for S&P 500 constituents this earnings season; a continuing expansion in the capital expenditure (capex) cycle; and the ongoing proliferation of AI applications. Wilson noted that upward revisions to earnings expectations are fueling the capex cycle. Combined with tax incentives and structural support from AI data center construction, capex growth is reaching 10%. The proliferation of AI applications is another significant market force: it compresses cost structures, reduces wage expenses, boosts earnings growth (particularly for small-cap stocks), and expands profit margins. A year ago, only 13% of S&P 500 companies mentioned benefiting from AI applications; by Q1 this year, that figure had risen to 25%. In sectors with high AI penetration, productivity growth per employee is faster and greater, significantly outpacing other industries.
Wilson recently examined the potential impact of the November midterm elections on the stock market. The firm believes the policy variables affecting stocks are mainly foreign policy, tariffs, and deregulation—areas within former President Trump's purview and policy tools he could directly utilize. Given the multitude of positive factors supporting the market, a common question investors face in the current recovery is: Will the market offer another opportunity to add risk assets? With passive investors generally underweight risk assets, Wilson believes any market pullback will be brief and fleeting. Concerns over a Federal Reserve leadership change or resurgent inflation could trigger episodic spikes in bond volatility and pressure on funding markets, but he views such shocks as manageable.