Latest Stock Pullback Shows How Stretched This Market Has Become
(Bloomberg) — The latest pullback in US stocks, a few weeks after their wobble in October, underscores how stretched the market has become and how sensitive it is to unfavorable news.
Risk assets moderated their slide on Wednesday, following the steepest drops in both the S&P 500 Index and Nasdaq 100 since Oct. 10. While there was no single catalyst for the slump, traders pointed to range of extended metrics that provided an easy trigger for a bout of profit taking.
Concerns about an ever-narrowing cohort of stocks driving the gains have become louder, while a hawkish pivot in Federal Reserve commentary has put a dent in optimism about interest-rate cuts. Technical indicators are increasingly flagging reasons for caution, adding to the drag on sentiment from warnings by Wall Street chief executives about frothy valuations.
“There are just a lot of things about this market that haven’t been adding up for a while,” says Goldman Sachs Group Inc. partner Rich Privorotsky. “We have been overdue a correction and the question is the magnitude.”
In one of the most eye-catching moves, Palantir Technologies Inc. sank 8% even after boosting its outlook, with its bullish AI prospects failing to offset angst that the rally in its stock has been excessive. Adding to the concerns, hedge fund manager Michael Burry disclosed bearish wagers on the firm and Nvidia Corp.
It’s not hard to find signs that gains may be overdone after a record-breaking surge in the past six months pushed valuations to levels associated with exuberance. The S&P 500 is trading at about 23 times forward earnings estimates, above its five-year average of 20. Similarly, the Nasdaq 100 index fetches a multiple of 28 times, against a low of about 19 in 2022.
“The market was priced for perfection,” said Alexandre Baradez, chief market analyst at IG in Paris. “That explains why emerging questions about rate cuts, liquidity, and valuations are having such an impact. Same goes for earnings, when you have priced perfection, even good results such as those of Palantir fail to lift up the share price further.”
Market internals show signs of overheating. Gains in the S&P 500 since April have seen the US benchmark decouple significantly from its moving averages. The gap with the 200-day gauge widened to 13% in October, a level that’s usually proved unsustainable in the past 15 years.
Meanwhile, the index has now traded above its 50-day moving average for the longest since 2011. These overbought signals don’t necessarily mean a correction is on the way, but they underscore how extended the run is.
The S&P 500 has hit a record high 36 times already this year, most recently on Oct. 28. At the same time, the breadth of the rally has been extremely narrow, with just six stocks contributing about half of the gains in the gauge since the start of 2025.
In two sessions last week, the S&P 500 notched significant outlier measurements of market breadth. On both Oct. 28 and the following day, the benchmark posted modest gains or was little changed, but the so-called Advance-Decline Index was deep in the red. The two prints rank among the weakest recordings of market breadth in the past 25 years.
The thematic force driving stock market gains remains clustered around the juiciest trades, from AI to quantum computing, Bitcoin and momentum, seemingly without concern about how expensive these have become.
Not only is the range of themes as limited as the S&P 500’s market breadth, but it also lacks any countering force. Shorting the AI capex train seems risky. It has even proved unwise to make relative bets, as some stock baskets post double-digit outperformance against the S&P 500.
There’s concern that capital expenditure by US companies is too heavily concentrated in AI and is being pursued by a small group of megacaps, while a number of smaller firms are actually reducing spending.
Earnings have proved resilient overall and ambitious buildout plans and partnership announcements have been greeted with further spurts higher in stock prices, though there are signs profit growth is slowing. Additionally, the bond market is now being tapped more to fund the investments, which adds a new layer to the capex story.
“The real question here is whether there’s an AI bubble, but with my team, we’ve looked at it concluded there’s not, it’s not the end of the AI story,” said Francois Rimeu, senior strategist at Credit Mutuel Asset Management. “Nvidia’s order book is full, capex is massive across the industry — so yes, there might be a few stocks whose valuations are questionable. But the AI trade still has legs.”
–With assistance from Julien Ponthus and Abhishek Vishnoi.
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