Wall Street's ‘hopium' high not exhausted yet

Globe and Mail

2 days ago

By any measure, the recent resilience of U.S. stocks is remarkable, with Wall Street powering through numerous headwinds to erase all its tariff-fueled losses and move into positive territory for the year. And although these headwinds haven't gone away, the rally may still have some juice left in it.
Since the April 7 lows plumbed after U.S. President Donald Trump's 'Liberation Day' tariff debacle, the S&P 500 and Nasdaq are up 23 per cent and 32 per cent, respectively. 'Big Tech' has led the way, with the Roundhill 'Magnificent Seven' ETF (MAGS-A) gaining more than 35 per cent.
On the face of it, this is remarkable given that many of the concerns that sparked the crash – elevated U.S. import tariffs, tensions between the world's two largest economies, and chaotic and unorthodox policy out of Washington – remain in place today.
Equity bulls are essentially betting that many things will go right in the coming months: the Federal Reserve will cut rates; no economic downturn; inflation won't spike despite the tariffs; U.S. tech companies will continue generating strong results; fiscal concerns in Washington will moderate; and perhaps most importantly, Trump will continue to back down on his most aggressive tariff threats – or to use the acronym de jour, investors are assuming the 'TACO' (Trump Always Chickens Out) trade will hold.
That's a lot of stars aligning.
Some of the biggest names in finance are skeptical, particularly regarding the U.S. fiscal outlook. Bridgewater founder Ray Dalio and JP Morgan CEO Jamie Dimon, both long-time deficit hawks, this week repeated their warnings that the U.S. debt is unsustainable. But these calls have fallen on deaf ears, or equity investors simply think any fiscal fallout will take years to materialize.
On the one hand, investors – especially the retail crowd believed to be driving this rally – appear to be overly optimistic. But looked at another way, U.S. equity investors may not be ignoring today's underlying risks, but simply viewing them less apocalyptically than they did a few months ago. Indeed, the overwhelmingly negative sentiment from earlier this year paved the way for the recent rebound.
Sentiment among institutional investors reached extreme levels of bearishness in the wake of 'Liberation Day', and recession fears ballooned to historically high levels as well, Bank of America's April fund manager survey showed.
Meanwhile, May's survey showed fund managers holding the biggest underweight position in U.S. equities in two years. When sentiment and positioning are that stretched, it doesn't take much for prices to snap back in the opposite direction.
If the latest American Association of Individual Investors (AAII) Sentiment Survey is any guide, the snap back in equities still has room to run. Pessimism over the short-term outlook for U.S. stocks increased to an 'unusually high' 41.9 per cent last week, above its historical average of 31.0 per cent for the 26th time in 28 weeks.
As HSBC's multi-asset strategy team noted this week, it is precisely because these sentiment and positioning indicators are being kept 'thoroughly in check' that market dips now are short-lived.
It's also good to remember that even though Wall Street has erased its early losses and valuations are rising back towards their recent highs, U.S. stocks are still laggards this year.
The S&P 500 is up only 1.5 per cent in 2025 thus far, while the MSCI All Country World Index has jumped around 6 per cent, hitting an all-time high on Wednesday. This suggests there may be room for U.S. outperformance on a relative basis in the coming weeks and months, though, of course, relative value metrics might still favor non-U.S. markets.
This doesn't mean we should expect capital to start flooding back into the U.S. again. International institutional investors may continue to rethink their allocation to U.S. assets, creating a long-term risk to U.S. stocks. But for now, domestic U.S. investors are picking up the slack.
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