Overheated Market? Analysts Watch These Red Flags

Even knowing that the market is forward-looking, the resilience of U.S. investors in 2025 has been impressive.

As of the market close on June 18, the S&P 500 index is up a little over 5% since hitting a 12-week low on April 4, 2025.

That puts it within striking distance of a new all-time high.

Some analysts believe that’s achievable. However, a lot of uncertainty needs to be resolved. Four specific questions are:

• What will the final tariff agreement between the U.S. and China mean for corporate earnings and consumers?

• Will other trade deals follow?

• Will the Trump administration’s “One Big Beautiful Bill” on taxes pass Congress, giving businesses clarity?

• How will those outcomes influence the Federal Reserve’s timing of interest rate cuts?

If any one of these questions breaks in an undesirable direction, it could send stocks lower. But most investors are more data-dependent than that. Trying to predict market tops is like trying to predict the weather. Even if an investor gets the direction right, the reason why may be drastically different.

Still, there are some clear signals that the market could be due for a strong pullback. That’s not a doom-and-gloom statement. Markets go up and markets go down. Long-term investors really don’t care, but for traders looking for short-term gains, here are three things to watch.

Mixed Signals Between Stocks and Bonds

One consistent indicator that forecasted three pullbacks in 1999, 2006, and 2021 is found in the S&P 500’s trading above its 200-day moving average, contrasted with treasury bond prices trading below it.

The former indicates that investors are bullish about corporate earnings. Why wouldn’t they? Companies are already taking steps to mitigate the impact of current and future tariffs. If that story comes in more benign than expected, it will be rocket fuel for companies that are leaning into AI to cut labor costs.

However, bondholders are sending a different signal. Concerns about potential inflation from tariffs and the Federal Reserve keeping interest rates at current levels may be transitory. But transitory has lasted longer than expected and it means the cost of capital is high. That’s not good for growth stocks, like many technology stocks, that rely on debt.

The Buffett Indicator Is Flashing Red

Another signal for investors to watch is the Buffett Indicator. This indicator compares the total market capitalization of a country’s stock market to its gross domestic product (GDP). Any number above 110% means stocks are overvalued. If that percentage goes over 140%, the market is deemed strongly overvalued. Right now, the indicator is 175%.

Has the Buffett indicator been wrong? Yes and no. It’s not a timing mechanism. In other words, stocks can continue to go up much longer than expected. That was the case in 1999 with the dot-com bubble. It was also the case between 2013 and 2019 when low interest rates propelled stocks to higher highs.

But the market doesn’t have ultra-low rates to rely on now. That doesn’t mean a crash is imminent; it just means that if it seems stocks are overvalued, it’s probably because they are.

High-Yield Credit Spreads May Be Too Calm

High-yield credit spreads measure investors’ appetite for risk. They indicate the difference in yield between lower-rated (i.e., junk) bonds and U.S. government bonds of the same duration. Right now, that spread is at 300 basis points, which indicates that investors don’t believe there’s much credit risk.

For that to be correct, many of the issues mentioned above would have to break the right way. That is, we have disinflation that forces interest rates lower and corporate earnings continue to be resilient.

However, the war between Iran and Israel is reminding investors that risk can enter the market in different ways, and frequently without warning.

Written by Chris Markoch

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