MW U.S. stocks are near record highs. Why are investors so worried?

By Joseph Adinolfi

Sentiment gauges have soured - but the S&P 500 was at record highs just a few days ago. What's going on?

Investors are growing increasingly worried that the bull market in stocks, which has delivered massive gains over the past two years, might be running out of steam.

Recently, a number of popular sentiment gauges have highlighted growing uncertainty about where the market might be heading next. The latest reading from the American Association of Individual Investors, published Thursday, saw the eight-week moving average of bullish sentiment slide to 33.9%, the lowest reading since November 2023. Bearish sentiment, meanwhile, remained elevated above its long-term average, although below a peak from late last week.

Similarly, a Friday reading from BofA Securities' bull and bear indicator came in at 5.3. That was up slightly from one week earlier, but still squarely in neutral territory. A reading of 1 on the gauge would represent maximum fear, while 10 would represent extreme euphoria.

Other gauges, including several cited by a Vanguard Group strategist in research shared with MarketWatch earlier this week, have also reflected rising anxiety.

U.S. stocks finished the week lower on Friday as early losses accelerated in afternoon trade. By the time the dust had settled, stocks had tallied their biggest daily drop of 2025, FactSet data showed. Investors blamed the latest batch of data, including readings on consumer sentiment and weakness in the services sector, for reviving fears about the U.S. economy.

Yet the S&P 500 SPX was trading at record highs as recently as two days earlier. And even if the momentum trade driving the market hit a bit of a speed bump this week, highflying stocks like Palantir Technologies Inc. (PLTR) and AppLovin Corp. (APP) are still sitting on solid gains - although most members of the "Magnificent Seven" megacap tech stocks have started to sputter, with the exception of Facebook parent Meta Platforms Inc. $(META)$

Still, ordinary investors who prefer index-tracking funds haven't felt much of a pinch, since other stocks have been rising to help compensate for the weakness of the Magnificent Seven, blunting the impact on indexes like the S&P 500 and Nasdaq Composite COMP.

But the divergence between how investors feel, and how they are acting, is certainly cause for befuddlement. The rally in U.S. stocks has slowed, but fundamentals like corporate profits and the state of the economy have remained strong. Quarterly earnings have largely delivered the strong profit growth that Wall Street had expected during the fourth quarter, and next week investors will receive a fresh reading on how the U.S. economy fared in late 2024.

So what, exactly, do investors have to be so worried about?

Quite a lot, actually. From stretched valuations to a chaotic pace of change in Washington, more risks have emerged. Even if stocks have so far avoided a sharp correction, the pace of their upward climb has definitely slowed.

"There has been a split between bearish sentiment on the attitudinal side, and bullish sentiment on the positioning side," said Kevin Gordon, a senior investment strategist at Charles Schwab.

That has perhaps started to change as of Friday, although it remains to be seen whether these late-day losses will carry over into next week.

Uncertainty surrounding President Trump's policies on trade, immigration and engagement with American adversaries like Russia has complicated the outlook for the U.S. economy.

Even if things look mostly OK right now, some are starting to wonder whether the president's agenda could have unintended consequences. Apollo economist Torsten Slok questioned earlier this week whether administration's firings of federal workers could push the economy into a recession.

But there are plenty of other risks that have nothing to do with Trump or Washington. Rising egg prices are stoking concerns about inflation, which were clearly evident in Friday's reading from the University of Michigan's consumer-sentiment gauge.

On Saturday, Warren Buffett's Berkshire Hathaway will release its latest earnings report, accompanied by Buffett's annual letter to shareholders. Investors will be watching to see whether the firm's cash pile, which stood at more than $300 billion as of the end of the third quarter, has continued to grow.

Buffett's unwillingness to put more money to work in the market has helped underscore concerns about rich stock valuations. Some say valuations look stretched relative to history, which could leave equities vulnerable to any disappointing news that might come along.

To be sure, investors haven't shown much of an appetite to actually pull money out of the market. While flows into U.S. equity funds have slowed from the breakneck pace of late last year, investors have so far continued to put money to work in U.S. stocks in February, according to data from EPFR.

But at the same time, some have begun putting more money to work in funds that track defensive assets like gold and bonds.

Meanwhile, investment managers surveyed by Bank of America have kept their allocation to cash at extremely low levels.

Schwab's Gordon said that he has lately been fielding more questions from clients about how Trump's immigration crackdown might impact the labor market, particularly in the U.S. agricultural sector.

"There has been this anxiety creeping into the market, whether it is trade-related or immigration-related. You can kind of take your pick with all that is going on in Washington," he said.

To be sure, a little bit of concern can often be a healthy thing for markets; there is a notion on Wall Street that stocks must sometimes climb a "wall of worry." Fundstrat's Tom Lee pointed out in commentary shared with MarketWatch on Friday that, when sentiment gauges have turned dour in the past, more stock-market gains have soon followed.

But others have warned that investors look unprepared for a selloff, meaning any further weakness could quickly snowball. Options traders have continued to favor bullish calls, while the Cboe Volatility Index VIX, also known as the VIX or Wall Street's "fear gauge," still looks pretty tame. The VIX finished Friday at 18.45, below its long-term average of around 20, even as markets tumbled.

Some said the expiration on Friday of options contracts tied to nearly $3 trillion in equities could have exacerbated the selloff.

"Even though there is nervousness, nobody is hedged," said Farzin Azarm, a managing director of equity trading at Mizuho Americas.

The S&P 500 fell 104.39 points, or 1.7%, on Friday to finish at 6,013.13. The Nasdaq Composite shed 438.36 points, or 2.2%, to 19,524.01. The Dow Jones Industrial Average DJIA lost 748.63 points, or 1.7%, to close at 43,428.02.

-Joseph Adinolfi

This content was created by MarketWatch, which is operated by Dow Jones & Co. MarketWatch is published independently from Dow Jones Newswires and The Wall Street Journal.

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February 22, 2025 07:00 ET (12:00 GMT)

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