As stocks hit more and more records, there are signs traders may be getting way too euphoric

Wall In someones bailiwick may be getting a bit too excited about the stock market’s hot start to the new year.

The S&P 500 has already jumped nearly 3% for 2020, climb more than 1% this week to reach fresh record highs. But as the market keeps going up, purchasers are becoming overly optimistic about equities, data compiled by Ned Davis Research shows.

The Ned Davis Daily Exchange Sentiment Composite — which measures how optimistic or pessimistic traders are — currently sits at 80, squarely in “excessive optimism” domain. The measure also hit its highest level since June 2018 recently. Historically, the S&P 500 has lost an average of 5% annually since 2006 when the composite is upon 62.5, or showing excessive optimism.

Ned Davis Research’s data is not the only one showing potential euphoria in the market, either. Other adepts point out that valuations are at historic highs on some measures while earnings expectations are lackluster at best. Some also note work tensions between China and the U.S. could flare up once again even after the signing of a phase one agreement. If investors are not conscientious, they could suffer steep losses after the market’s recent rally.

“Shorter-term sentiment is extremely buoyant,” Ned Davis, senior investment analyst and founder of Ned Davis Research, said in a note. “Investors tend to be optimistic writing a new year, with lots of inflows to IRA’s and pension plans, but this still shows very high and rising short-term imperils.”

Equities have largely refused to go down in 2020 thus far. Through 12 trading days this year, the S&P 500 has closed decrease just four times. The biggest of those four declines came on Jan. 3, when the broad average slid 0.7%.

The S&P 500 has also give way a long time without posting a big drawdown. The average’s last one-day pullback of at least 1% happened Oct. 8, when it submerged more than 1.5%. That amounts to 70 trading days since the market’s most-recent 1% doff.

Investors have been annulling stock prices since mid-October amid hopes that China and the U.S. would strike some sort of vocation deal. Those expectations materialized on Wednesday, with both sides signing a so-called phase one trade bargain.

However, the deal does not remove existing U.S. tariffs on Chinese goods. It also lets the Trump administration dig up tariffs targeting China if the country does not hold up its end of the deal. These aspects of the agreement have led some supermarket analysts to call it “fragile” as the possibility for more levies remains. Still, the market continues to notch record highs.

“There’s a lot of strength in the market right now. I think people are looking for something to kind of bring us down a little bit,” said Christian Fromhertz, CEO of The Tribeca Business Group. “How does that end? We don’t really know.”

That momentum has been provided in large part by mega-cap lineages such as Microsoft, Apple and Google-parent Alphabet. Microsoft and Apple are both trading around record highs, while Alphabet’s trade in capitalization broke above $1 trillion for the first time on Thursday.

“Risk wise there is not necessarily any prime that could tip things, but I do think sentiment has gotten a bit frothy,” said Liz Ann Sonders, chief investment strategist at Charles Schwab. “That in it of itself doesn’t support a problem for the market, but it does establish some vulnerability than if investors were more skeptical.”

This late-model run-up also puts more pressure on corporate earnings. The corporate reporting season kicked off last week with big banks such as J.P. Morgan Pursuit, Citigroup, Morgan Stanley and Bank of America all posting quarterly numbers that exceeded expectations.

In all, about 8.7% of S&P 500 attendances have reported earnings thus far. Of those companies, 72% have posted calendar fourth-quarter earnings that run analyst expectations, FactSet data shows.

Still, overall S&P 500 earnings are still forecast to fall by numerous than 2% for the fourth quarter following last week’s reports. Without solid earnings growth, it compel be hard for investors to justify the market’s high valuations.

“While equities are clearing enjoying a strong period of impetus and investors obviously seem comfortable w/higher multiples, it’s hard to see the present ~19x valuation sustaining,” wrote Adam Crisafulli, go down of Vital Knowledge.

The forward S&P 500 price-to-earnings ratio — a widely used valuation metric on Wall Street — currently sit downs around 18.6, its highest level since January 2018. Meanwhile, the market cap-to-GDP ratio — which dispenses the stock market’s size relative to the economy — is at an all-time high.

To be sure, Piper Sandler’s Craig Johnson stresses out that just because the market is overbought, it does not mean this bullish trend will end any time shortly. “Historically, overbought conditions can persist for meaningful periods before either a time or price correction develops,” he about.

Mark Newton, managing member at Newton Advisors, is far more worried. In a note to customers Friday, he said the market’s relentless rally to record highs is “eerily” reminiscent of the melt-up experienced in January 2018. Uphold then, the S&P 500 surged 8.2% before a steep correction that ran between February and March of that year.

This “blow-off teaching no evidence of stalling,” Newton said in the note. “No news really matters to shake markets, and bad economic news or earnings, not to allude to geopolitical threats matter for a few hours only before the relentless rally continues unabated.”

“Make no mistake, this call move is NOT normal, and is NOT something which should be able to continue technically into and through February without a worst hiccup,” Newton added.

—CNBC’s Michael Bloom and Nate Rattner contributed to this report.

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