Investors Are Betting on a Market Melt-up

The post-election market rally in the United States has driven up the value of assets ranging from shares in technology and manufacturing firms to cryptocurrencies, sparking investor optimism about the potential for continued growth. Many believe the surge, which has pushed the S&P 500 above 6000 for the first time, has more room to climb.

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Investor enthusiasm is evident in fund flows. U.S. equity-focused exchange-traded and mutual funds attracted nearly $56 billion in the week ending Wednesday, marking the second-largest weekly inflow since 2008, according to EPFR data. This influx extends a seven-month streak of gains for these funds, the longest since 2021, when an intense market upswing led stocks to new records.

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Driving this wave of optimism is a combination of factors, including expectations of lower taxes and reduced regulation under Donald Trump’s second term as president. According to Dominic Rizzo, a technology portfolio manager at T. Rowe Price, policies like tariffs could bolster U.S. manufacturing, fueling domestic investment and spending. Additionally, the end of election uncertainty has allowed many investors to feel more confident about the market’s direction.

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The sentiment among individual investors reflects this enthusiasm. A survey by the American Association of Individual Investors showed a significant jump in bullishness, with 49.8% expressing optimism about the market. Neutral sentiment fell to its lowest point since 2022, and about 40% of respondents said the election results made them more positive about market prospects.

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“Animal spirits are alive and well,” Rizzo said. While overseeing investments in tech giants like Nvidia, he remains optimistic, especially ahead of the company’s upcoming earnings report. Investors are also closely watching the presidential transition to gauge how new policies might affect market winners and losers.

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However, not all market watchers are convinced the rally is sustainable. Some caution that while pro-market policies could drive growth, they might also introduce inflationary pressures and heighten volatility. For instance, stocks wavered toward the end of last week, and bitcoin prices retreated. The appointment of vaccine skeptic Robert F. Kennedy Jr. as health and human services secretary created headwinds for companies like Moderna and Pfizer. Meanwhile, Tesla, which surged post-election to reclaim a market capitalization above $1 trillion, has seen its shares falter in recent sessions. Even Trump Media & Technology Group experienced a 12% decline for the week.

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Despite these hiccups, the broader market has shown resilience. The S&P 500 and Nasdaq Composite closed last week within 3.2% of their respective record highs. With only a few weeks left in 2024, the S&P 500 is poised to gain over 20% for the year, marking consecutive years of significant growth—a feat achieved only three times in the past century, according to Deutsche Bank.

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For individual investors like Joe Johnson, 37, the rally has been rewarding. Johnson, who has invested in high-performing stocks such as Nvidia, Tesla, and cryptocurrency-focused MicroStrategy, has seen his portfolio grow substantially this year. Feeling bullish about the market, he plans to allocate more cash to stocks, particularly industrial names like Caterpillar and Deere, which he believes will benefit from a robust economy. Johnson’s optimism extends beyond the market, as he anticipates that Trump’s policies will also boost his small business in Maryland, which sells boat maintenance kits and engine parts.

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Small-cap stocks, which are highly sensitive to economic conditions, have also gained traction. The Russell 2000 index has risen nearly 2% since the election, and one of the largest exchange-traded funds linked to the index recorded $3.9 billion in inflows in a single day, the highest since 2007. Additionally, bullish positions in the futures market have reached their highest levels in over four years.

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Riskier segments of the financial market are thriving as well. Call option trading, which allows investors to bet on rising stock prices, has seen three of its busiest days ever this month. This surge has increased the cost of bullish trades. In cryptocurrencies, bitcoin prices soared past $90,000, and Dogecoin’s value skyrocketed after Trump announced plans for a government-efficiency initiative, co-led by Elon Musk. Dogecoin’s market capitalization now exceeds that of Ford Motor.

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However, rising valuations have some analysts urging caution. The S&P 500 recently traded at 22 times its expected earnings over the next 12 months, above its five-year average of 20. Bank of America strategist Savita Subramanian described market sentiment as “dangerously bullish” in a note.

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Meanwhile, the bond market signals potential challenges ahead. The 10-year Treasury yield rose to 4.426% on Friday, up from 4.072% a month earlier, as investors priced in expectations of higher deficits and inflation. Federal Reserve Chair Jerome Powell’s indication that rate cuts may take time has added pressure on bonds and stocks alike.

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One critical metric, the equity risk premium—the difference between the S&P 500’s earnings yield and the 10-year Treasury yield—has narrowed to its lowest point since 2002. This suggests that the potential reward for holding stocks over bonds is shrinking.

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“The market is awfully expensive to have a melt-up,” warned Rob Arnott, founder and chairman of Research Affiliates. Despite the current rally, some investors are questioning how much further the market can climb without becoming overheated.

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