The current U.S. stock market is at a watershed where “high sentiment” and “inflated earnings” coexist. On the one hand, Bank of America‘s extreme sentiment indicators suggest heightened short-term correction risks, and its strategists explicitly advise adopting a defensive posture. On the other hand, the high earnings growth of technology stocks largely relies on book value revaluation, and its solidity is far less impressive than it appears on the surface. Although valuation compression and hedge fund inflows have provided some support for the technology sector, macro-level uncertainties such as inflation, interest rates, and fiscal deficits are re-accumulating, becoming concerns that cannot be overlooked. For investors, maintaining vigilance over growth quality and macro risks amid optimistic sentiment may be the more prudent choice at present.
A strategist team led by Michael Hartnett stated that the bank’s proprietary “Bull & Bear Sentiment Indicator” has risen to 9.7, the highest level since 2021. The strategists analyzed that the broadening of the stock market rally, heavy inflows into high-yield bonds, and the continued narrowing of credit spreads have jointly fueled the warming of optimistic sentiment.
In the face of this situation, the Bank of America team explicitly expressed a preference for defensive assets, believing that such assets can effectively buffer shocks from potential negative surprises in the economy, monetary policy, and the artificial intelligence field. Hartnett emphasized that the team still adheres to the view of a “summer retreat or rotation” rather than “re-adding positions,” advising investors to reduce risk exposure and rotate into defensive sectors, duration assets, and the U.S. dollar.
This warning comes amid a strong U.S. earnings season. Better-than-expected results have reignited investor confidence in the AI outlook, driving a tech rally and pushing U.S. stocks to new record highs this week. However, structural issues lurk beneath the impressive data. According to an internal Goldman Sachs report, S&P 500 constituents posted a 45% year-over-year EPS growth in the second quarter, but excluding fair value changes in equity investments held by large technology companies, that figure would be cut in half to 26%. This means that nearly half of the “record” growth stemmed from book value revaluation rather than substantive expansion in operating profits. Meanwhile, AI infrastructure-related stocks contributed one-third of the index’s overall earnings growth, highlighting the high concentration and fragility of the growth.
Notably, the large-scale deleveraging during last month’s adjustment led hedge funds to cover a significant number of shorts. Goldman Sachs data show that last week, hedge funds increased their holdings in the information technology sector at the fastest pace since December 2022, with all of the “Magnificent Seven” receiving net buying, and current positions remain relatively low, suggesting further room for adding positions ahead.
However, major Wall Street banks also caution that macro risks are building. Goldman Sachs experts pointed out that after earnings season ends, market focus will shift back to interest rates, inflation, and economic growth, and U.S. Treasury volatility has already re-emerged. Société Générale’s strategy team warned that factors such as tariffs, an accelerating capital expenditure cycle, oil price volatility, and massive fiscal deficits all suggest that inflation expectations may be far below where they should be. The bank expects core PCE to remain above 3% this year and recommends allocating to inflation-protected bonds, copper, and gold to hedge against risks.
