Fear no more: what "red flags" investors ignore

After a long decline at the end of winter and a collapse in April, the market has not only recovered its losses but also entered the plus side: since the beginning of the year, the S&P 500 has gained more than 6%. The rally with small breaks has been going on for the second month, since April this year;

On Friday, June 27, the S&P 500 Index updated its all-time high. And not so long ago, the index was on the verge of a bear market.

But now risk appetite is back. Investors are betting on tech giants and stocks with high beta ratios (indicates how volatile securities are) - even in periods of drawdowns, noted Bloomberg: the Invesco High Beta ETF (Invesco High Beta ETF) is on track for its best quarterly performance since 2020 compared with ETFs for low-volatility stocks. The Goldman Sachs index for companies with weak balance sheets is on track to perform better relative to the S&P 500 since January, Bloomberg wrote on June 26. 

"We are surprised at the speed with which the market has moved from record pessimism to hype," says Julian Emanuel, chief strategist at Evercore ISI. 

"To be honest, I'm a little concerned about this rally," Kate Moore, chief investment officer at Citigroup's wealth management unit, said to Bloomberg. - There are a number of warning signs that are not affecting investor sentiment yet. And frankly, I don't understand why they're not on their radar."

Previously, Wall Street analysts had expected the S&P 500 to rise 13% by the end of the year, followed by Bloomberg Intelligence data. But they have now lowered the forecast to 7.1%. Moreover, tech giants such as Nvidia, Microsoft and Meta are driving the index's growth. The Equal-weighted S&P 500 Index (in which all companies are equally weighted) is rising more slowly than the main. Both moved with similar momentum at the beginning of the year and reached their previous peak on Feb. 19, but after falling, the equal-weighted index recovered to that level a week later than the main index.  

As the rally continues, warnings about the overvaluation of the S&P 500 Index are growing louder. Its forward P/E multiple is 22, meaning investors are paying $22 for every dollar of profit that companies in the index will earn over the next 12 months. That's 35% above the historical average, notes Bloomberg.

What are the "red flags" and warning signals in the market that investors should not ignore? 

Investors are no longer afraid of US duties. The market believes that the threat of tariffs is used by the U.S. administration more for pressure than for actual implementation - every "loud" announcement will be followed by a rollback. Even the phrase Trump Always Chickens Out (TACO, "Trump always gives up") has appeared, the Financial Times wrote. It means that the market is no longer taking tariff threats seriously, but is evaluating them as an element of tactics and media strategy. "The recent rally is largely because markets have realized: the U.S. administration has no tolerance for pressure from markets and the economy and is quick to back down when duties start to 'hurt.' That's the TACO theory," says FT Unhedged podcast host Robert Armstrong.

On July 9, the pause in imposing duties that U.S. President Donald Trump took in April expires. He has already announced that his administration will start sending letters to trading partners on Friday about the imposition of higher duties from August 1, ranging from 10% to 70%. 

To date, the US has managed to conclude only a few agreements - with the UK, China and Vietnam. The deal with India is stalled, and new difficulties have arisen with Canada: the U.S. first refused to continue negotiations, but then the parties returned to discussing a trade deal. 

"Predicting the Trump administration's actions on duties is extremely difficult. Negotiations are underway with several countries at once, but the degree of readiness of these agreements is extremely low," says Nicolo Bragadza, manager of Morningstar Wealth, in an interview with MoneyWeek. - Investors should prepare for different scenarios and focus on fundamentals rather than headlines."

Investors are naive if they think companies won't feel the impact of duties, given the role globalization has played in profitability growth over the past two decades, Kate Moore also warns.

The "Big Beautiful" law that Trump signed on July 4 also carries risk.  

The mere discussion of the bill has previously sparked a selloff in 10-year Treasury bonds, noted The Wall Street Journal. According to a Congressional Budget Office (CBO) estimate, the bill predicts a nearly $3.4 trillion increase in the U.S. government deficit over 10 years - and that's without taking into account the cost of servicing the new debt and the macroeconomic impact.

The threat posed by high U.S. budget deficits is becoming increasingly important to financial markets. In 2024, the federal budget deficit would total  $1.8 trillion. JPMorgan Chase CEO Jamie Dimon has issued a grim warning: if the authorities don't act, the country could face a debt crisis. "You're going to see a crack in the bond market, OK?" - he declared.

The fact that rising U.S. deficits have not yet triggered an unsustainable debt spiral doesn't mean it will never happen, says Barron's Christopher Smart, managing partner at Arbroath Group.

Another reason for investor optimism is the expectation of a rate cut. Investors increasingly expect the Fed to cut rates, notes Bank of America strategist Michael Hartnett. According to him, there is a growing risk of an "explosive bubble" forming in the second half of the year.

The Federal Reserve plans to cut its key rate twice at the end of 2025, following the regulator's forecast. Fed Chairman Jerome Powell said earlier that the economy is in a solid state and the central bank is in a good position to wait for additional data to make a rate decision. 

Negative trends are also noted in the regulator's forecast. Thus, the Fed revised the forecast for real GDP growth in the U.S. for 2025 - the figure was reduced from 1.7% to 1.4%. The regulator also increased the inflation forecast for this year - from 2.7% to 3%.

Moreover, the Fed may be preparing for a longer period of high rates. Although the regulator has maintained its plan to cut rates twice in 2025, the regulator expects only one rate cut next year. 

"We have to remember that lower rates will be a response not only to lower inflation, but also to lower overall economic activity. And a decline in overall activity is not an ideal environment for large-scale risk," said Kate Moore of Citigroup Wealth.

In its latest forecast, the Fed also raised the expected unemployment rate from 4.4% to 4.5%, which, although it looks like a minor change, reflects the regulator's growing concern about the employment rate. The June labor market report was unexpectedly strong, with the number of jobs (excluding agriculture) increased by 147,000, while economists expected only 110,000  

But from the beginning of the year through May average U.S. job growth was only 124,000 per month, compared with an average of 168,000 in 2024, The Wall Street Journal wrote. 

Nearly 1 million people left the labor market over the past month, a record for a month outside of a recession or crisis, wrote Morgan Stanley Wealth Management Chief Investment Officer Lisa Shalett in mid-June. She ranks the state of the labor market as a risk that investors are better off not ignoring. The number of jobless claims has reached a four-year high, she notes. In addition, both voluntary layoffs and hiring rates are declining. All of this suggests that the market is unable to fully absorb new graduates, Shalett concludes. The state of the labor market is an important indicator because it is linked to consumption, which accounts for about 60% of U.S. GDP.

Of additional concern is the sharp slowdown in consumer spending, a critical component of U.S. GDP.

In Q1 2025, the index grew at the slowest pace since the pandemic, with overall growth of just 0.5% year-on-year, and the contribution of services spending to GDP growth was the lowest since Q2 2020, at just 0.3 pp, according to data from the Bureau of Economic Analysis, as reported by Bloomberg.

U.S. first-quarter GDP declined at an annualized rate of 0.5%, signaling an unexpected slowdown.

The reporting season will be an important barometer for the market. Corporate results for the second quarter will reflect the "immediate impact" of the duties, and investors will be assessing the damage from the trade war, write Goldman Sachs analysts. 

According to data from Bloomberg Intelligence, earnings growth for S&P 500 companies is expected to be just 2.8% year-over-year, the weakest in two years. Only six of the index's 11 sectors are expected to show earnings growth, according to estimates from Yardeni Research.

Lisa Shalett of Morgan Stanley writes about the alarming signals for investors here as well. The ISM index, which tracks companies' spending on raw materials and services, continues to rise. And the rise in the producer price index is outpacing the rise in the consumer price index, suggesting that companies can't fully pass on rising costs to consumers. The Fed survey data that cites Shalett confirms this: only about 50% of companies have been able to pass on more than half of the costs associated with duties to customers. As a result, businesses are having to sacrifice their margins.

This article was AI-translated and verified by a human editor