Key Points
- The S&P 500 and Nasdaq surged more than 20% after Trump paused tariffs on April 9.
- Investor sentiment rebounded from April’s oversold levels but is now more neutral. The Fed paused rate cuts amid inflation concerns, limiting bullish momentum.
- AI investment may be peaking due to cheaper international alternatives.
- Valuations are stretched, with the S&P 500 trading above historical P/E averages. Rising Treasury yields and Moody’s U.S. debt downgrade add pressure to equities.
The stock market has surged since President Donald Trump paused most reciprocal tariffs on April 9. The S&P 500 gained nearly 20%, while the Nasdaq Composite rose 24% from its April lows. This rally followed a sharp sell-off triggered by earlier tariff announcements that stoked inflation and recession fears, pushing the market into oversold territory.
Investor optimism returned as hopes grew for milder tariff outcomes through negotiation. However, many underlying risks persist.
After strong double-digit returns in 2023 and 2024, optimism around the Federal Reserve’s monetary easing and explosive AI investment began to fade. Although the Fed cut interest rates late last year, it has since paused further reductions amid concerns that inflation progress has stalled. April’s Consumer Price Index (CPI) held steady at 2.3%, above the Fed’s 2% target.
The rally also faces headwinds from concerns about slowing AI investment. The arrival of Deepseek-R1, a low-cost Chinese AI rival to ChatGPT and Gemini, signaled a potential peak in AI infrastructure spending, especially from tech giants like Amazon and Google.
Another concern is the stock market’s valuation. The S&P 500’s forward P/E ratio now stands at 21.4, higher than its 5-year average (19.9) and 10-year average (18.3), a level that historically leads to negative one-year returns.
Sentiment has also cooled. In April, indicators like the Fear & Greed Index and the put/call ratio signaled extreme fear. Those indicators show moderate optimism today, reducing the likelihood of further short-term rally fuel. In addition, the Relative Strength Index (RSI) for the SPY and QQQ is now near or above 70, suggesting overbought conditions and the potential for a pullback.
Adding to the caution, Moody’s downgraded U.S. debt on May 15, prompting Treasury yields to rise significantly. The 10-year yield rose to 4.59%, while the 30-year jumped to 5.08%, pressuring equity valuations and signaling market caution.
