Bullish U.S. stock investors are clinging tightly to the perfect "Goldilocks" fantasy, pushing market risk appetite to its extreme. It has become so difficult to discern: what could possibly ignite the next fuse to drive the broader market higher?
While this week's lower-than-expected U.S. inflation data gave the market a temporary shot in the arm, the effect was fleeting. U.S. stocks are now struggling near historical highs, finding it difficult to set new records. Meanwhile, the 10-year U.S. Treasury yield remains stubbornly around 4.6%, and the U.S. Dollar Index is holding near levels not far from its May 2025 peak. Despite a generally positive start to this earnings season, these taut macro conditions act like a tightening band, firmly suppressing the bulls.
Richard Privorotsky, a partner at Goldman Sachs, points out, "Whether U.S. stocks can continue to rise will depend on the corporate guidance provided and the market's positioning structure, not the headlines themselves. Energy remains a key macro risk, but the inflation situation is currently improving."
Privorotsky believes this earnings season is highly likely to deliver a strong report card. Major banks have already easily passed their earnings tests, and ASML's results confirmed that capital expenditure demand in the semiconductor sector remains robust.
"Similar to the situation faced by most AI concept stocks, the core question is no longer whether the earnings numbers look good, but whether these numbers are impressive enough to justify the currently elevated positioning," Privorotsky noted.
Systematic Strategy Positioning Nears Historical Limits
In a sense, the hidden dangers behind the market's exuberance are indeed quietly accumulating.
A Bank of America fund manager survey released this week shows that professional investors' cash levels have now fallen to extremely low levels, and the bank's 'Bull & Bear Indicator' is flashing a warning signal.
Furthermore, according to Deutsche Bank data, systematic strategies are already fully loaded, leaving limited room for incremental buying to add more positions. Trend-following CTA funds have pushed their equity holdings into the upper half of the historical range, currently at the 72nd percentile. For volatility control funds, this ratio is even more extreme, sitting at the 91st percentile.
This extreme phenomenon of "running out of ammunition"—persistently high positioning levels—is also reflected in fund flows.
Arthur van Slooten and his team at Société Générale point out that although the absolute amount of money flowing into bond and money market funds this year has exceeded that into equity funds, both are far behind the surge in assets under management for the latter. In the $72.9 trillion fund market tracked by EPFR Global (excluding commodities), equity funds now account for a record 64.7% of total assets.
They wrote: "In other words, fund investors' risk appetite is at an all-time high."
The Broader Market Environment Remains Optimistic
Of course, against a backdrop of falling inflation and strong economic and earnings growth, this bullish stance seems justified. With this week's U.S. CPI and PPI data both showing easing price pressures, the Federal Reserve may adopt a more dovish stance in the coming weeks.
"For market bulls, this is even better than what 'Goldilocks' could imagine," said the J.P. Morgan Market Intelligence team led by Andrew Tyler. They stated that the inflation data should eliminate any concerns about a July rate hike and could ease worries about a September hike. "This sets the stage for the market to move higher and broaden the rally in the process."
Currently, the J.P. Morgan team continues to favor a 'barbell' strategy combining tech and cyclical stocks and recommends healthcare stocks as an uncorrelated hedge. Within the tech sector, they believe the consensus of "long semiconductors, short the 'Magnificent Seven' or software" could shift, as buying may return to the 'Magnificent Seven' given their relatively low valuations.
However, they warn that investors may first need to see an increase in end-user AI adoption rates or an acceleration in corporate earnings growth, enabling companies to reduce their future reliance on credit markets.
In the meantime, the next wave of the rally may still depend on momentum trading. Although positioning in this area has undergone some cleansing after a brutal sell-off, overall investor positioning remains elevated. While some sector rotation could help sustain the gains, given how much momentum trading has driven the market higher over the past year, it may require even more momentum to push the benchmark indices further.
"Over the past three weeks, market leadership has been tested, and the momentum factor has experienced its sharpest sell-off since the early 2000s," said a team of Goldman Sachs strategists led by Andrea Ferrario. "While oil has re-emerged as a significant driver of cross-asset returns, momentum trading still dominates in equities."
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