Market performance in the long term is primarily anchored in fundamental economic factors. However, in shorter time frames, sentiment and momentum exert a pronounced influence on returns. When investors collectively adopt an optimistic outlook, this can elevate equity valuations and foster extended rallies in stock indices.
The recent surge in enthusiasm spurred by advances in artificial intelligence (AI) technology has propelled U.S. stocks to achieve three consecutive years of double-digit gains. This period of robust returns has not only bolstered sentiment significantly but also elevated it to rare historical highs.
Bank of America’s latest global fund manager survey sheds light on these elevated confidence levels through its Bull & Bear Indicator metric. Recorded at 9.4 in January, this score falls within what the survey describes as "hyper-bull" territory, representing the highest mark since January 2018.
Understanding the significance of the 2018 benchmark requires a closer examination of how investor optimism can manifest in risky market behavior. During 2017, the S&P 500 index delivered a near 20% return, with gains continuing into early 2018. Concurrently, the Chicago Board Options Exchange Volatility Index (VIX) was maintaining historically low levels, frequently residing in the high single digits for prolonged periods.
Such stability encouraged investors to engage in trading volatility-linked futures contracts with a bearish stance on volatility itself. This trade was profitable so long as the VIX remained suppressed. However, volatility made an abrupt comeback in February 2018, an event now colloquially labeled "Volmaggedon." During this period, the VIX spiked to around 50 within days, causing significant losses for those positioned against volatility and triggering a 10% drop in the S&P 500.
Importantly, the rise in the Bull & Bear Indicator to elevated levels occurred mere weeks before this correction, illustrating how extreme bullishness can serve as a precursor to volatile market reversals.
Beyond the 2018 example, the Bull & Bear Indicator has also flagged critical market shifts in other instances. In February 2020, the indicator suggested conditions that were overbought just prior to the COVID-19 pandemic's onset. The subsequent economic shutdowns precipitated a severe equity market decline exceeding 30% by March of that year.
Similarly, in 2006 and 2007, recurring overbought signals from the indicator corresponded with widespread market optimism surrounding continually rising home prices. This overconfidence contributed to excessive leveraging, which culminated in the 2008 financial crisis, a dramatic housing market collapse, and an S&P 500 decline surpassing 50%.
These historical precedents underline the practical value of the Bull & Bear Indicator as a tool to gauge extremes in investor sentiment that often precede market turmoil. It is prudent, however, to note that this indicator is not infallible but rather serves as a useful alert alongside other market analysis.
Currently, the combination of a very high Bull & Bear reading and a global fund manager survey reflecting an unusually large allocation to equities with diminished cash positions suggests that market participants might be exhibiting a similar degree of overconfidence as seen in past periods that led to significant corrections.
Such positioning presents vulnerabilities within the U.S. stock market, potentially setting the stage for a pronounced pullback as experienced previously. This observation warrants heightened awareness among investors and stakeholders monitoring market dynamics as 2026 unfolds.