5 Signs The Market Is Getting Overheated

Every bull market climbs a wall of worry. But sometimes, it pays to stop and ask whether the climb is getting steeper than usual. Today's market setup bears an eerie resemblance to prior late-stage cycles, and the risks appear to be rising, even as the S&P 500 notches new highs.

Let's start with a technical snapshot that doesn't get much airtime on CNBC. The S&P 500 is trading above its 200-day moving average. That's a long-term trend marker suggesting extreme optimism. Meanwhile, Treasury bond prices are sitting below their 200-day moving average. This divergence doesn't happen often, and when it does, it tends to show up in the final innings of economic expansions.

We've seen this movie before: 1999, 2006, 2021.

Each time, equity investors pushed ahead, convinced corporate profits would keep expanding forever.

Bondholders, however, had already started worrying about inflation, interest rates, or worse. In every case, the equity euphoria gave way to painful reversion.

Right now, we're watching the same dynamic unfold.

Yields are up across the curve. Bonds are under pressure. Stocks are shaking off bad news and beneath the surface, the cost of capital is rising, especially for leveraged firms and growth stocks. History says this is a dangerous setup.

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We've run our full battery of forward-looking models, and nearly all suggest that future returns from U.S. equities will be underwhelming at best. In plain language: most of the gains are already behind us.

The CAPE ratio is back above 33, which is higher than 95% of historical readings. That's only been eclipsed twice: in 1929 and 1999.

Both preceded brutal drawdowns.

Even more concerning, the Excess CAPE Yield, essentially a measure of how much stocks yield versus bonds, is now negative. Bonds are expected to outperform equities on a valuation-adjusted basis. That's rare. And it's not bullish.

Meanwhile, market cap to GDP (the "Buffett Indicator") is around 175%. That's miles above its historical average. Investors own more stocks than ever, according to Fed data. Household equity allocations are above 45%. When allocations get that high, forward real returns typically fall below 2%.

Tobin's Q, the ratio of market value to asset replacement cost, is more than double its historical average. And the term premium on 10-year Treasuries is near zero—meaning there's little cushion for risk assets if the Fed has to stay restrictive longer than the market expects.

High-yield credit spreads—measuring the yield premium that lower-rated corporate bonds pay over Treasuries—are among the most reliable barometers of financial market risk. Today, those spreads remain historically tight, hovering around 300 basis points. That's well below the long-term average of about 500 basis points, and only marginally higher than the ultra-complacent levels seen during the 2006–07 cycle and parts of 2019.

In plain terms, the market is not pricing in much credit risk. That may reflect optimism about soft landings, disinflation, and resilient earnings—but from a longer-term perspective, it's concerning.

Tight spreads mean investors are not being compensated for default risk. Historically, when spreads are this compressed, forward returns for both high-yield debt and equities tend to be modest. More importantly, such periods often precede volatility spikes, widening spreads, and, eventually, equity drawdowns, especially when economic conditions deteriorate or monetary policy tightens further.

A growing and underappreciated macro risk is the revival of protectionist trade policies. Across both political parties, support for tariffs and domestic reshoring is surging. New tariffs—whether on Chinese electric vehicles, semiconductors, or critical minerals may win political points, but economically, they act as a tax on supply chains.

This raises costs, suppresses productivity, and creates inflationary friction—without stimulating enough domestic demand to offset the drag. That's how you end up with stagflation: slow growth and sticky inflation. It's the most dangerous macro cocktail for both bonds and equities.

Investors should remember that much of the post-1990s disinflationary boom was powered by global supply chain integration and cheap imports. Rolling that back won't just raise input costs, it will lower operating margins and real wage gains. And if retaliatory tariffs follow, as they often do uncertainty will climb just as fast as prices.

Markets may not yet be pricing in this risk, but it looms large for 2025 and beyond.

There's also the issue of rising yields. While modest yield increases can accompany economic growth, rapid or disorderly moves tend to hurt equities, especially long-duration stocks like tech and companies that rely heavily on debt financing.

Let's not sugarcoat it: higher yields mean higher borrowing costs. They mean increased competition from fixed income. And they raise the discount rate on future cash flows, compressing valuations.

If inflation proves sticky or the Fed is forced to keep rates elevated, this will likely weigh on corporate margins and investor risk appetite.

We saw this in 2022. We saw it in 1994. We saw it in 2018. The results weren't pretty.

This isn't a call to go to cash. But it is a warning that the air is thin up here.

Most valuation metrics suggest we are in rarefied territory, where expected returns don't justify the risks. And the bond and credit markets, often better macro forecasters than stocks, are sending conflicting signals.

Tight spreads and high valuations rarely coexist for long in a tightening cycle.

Now add to that a potential wave of trade-driven inflation and supply chain risk. The margin for error is shrinking, and the volatility premium looks underpriced.

The prudent move now may be to rebalance toward value and income.

International markets, small-cap deep value, and income-producing assets all deserve fresh attention.

The message from history and the data is simple: markets don't reward complacency. They punish it.

We'll be watching closely. Stay alert.

Editorial content from our expert contributors is intended to be information for the general public and not individualized investment advice. Editors/contributors are presenting their individual opinions and strategies, which are neither expressly nor impliedly approved or endorsed by Benzinga.

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