An historic surge in United States stocks has pushed equities to fresh highs, yet signs of overheating sentiment suggest that the rally may be entering a slower phase.

The rebound from the March lows, fuelled in part by hopes of easing tensions between the U.S. and Iran and a surge in corporate earnings, has lifted investor sentiment toward what a quantitative model from Bloomberg Intelligence strategists suggests is “manic” territory. The model tracks six components, and three of them have driven it toward that level: high-yield corporate bond spreads, low volatility, and pairwise correlations.

That doesn’t necessarily mean a crash is coming: The backdrop has typically coincided with further gains, albeit at a more modest rate. From 2012 through 2023, the Russell 3000 Index delivered an average return of 2.9 per cent in the three months following repeated elevated sentiment readings, according to BI’s Market Pulse model. During those periods, large-cap stocks tended to outperform, with the S&P 500 beating the small-cap Russell 2000 by about 178 basis points.

Get the latest headlines, breaking news and columns.

A welcome email is on its way. If you don't see it, please check your junk folder.

The next issue of Top Stories will soon be in your inbox.

We encountered an issue signing you up. Please try again

Still, the current episode stands apart from past surges. Historically, outsized monthly gains of this magnitude have tended to follow deep market drawdowns, such as in April 2009 and April 2020, when equities rebounded from crisis-driven lows. This time, stocks rallied to record highs from an already elevated base, a dynamic that could limit future upside.

“When everything works at once — growth over value, cyclicals over defensives — it’s usually a late-stage tell, not a fresh start,” BI’s Christopher Cain and Nathaniel Welnhofer wrote. “History says returns can still be positive, just less rewarding, with leadership narrowing back to large caps.”

The S&P 500 climbed more than 10 per cent in April, marking its fifth-best monthly performance in the past 35 years and pushing the benchmark to fresh all-time highs. It’s already tacked on another 2.2 per cent less than a week into May. Futures on the S&P 500 traded 0.1 per cent higher at 7:32 a.m. in New York.

Source: Drudge Report