Are Stocks Topping? What Nasdaq, Semis, and VIX Say About Risk Now

During a recent trading session, 400 stocks in the S&P 500 declined, yet the index still advanced. For experienced traders, this isn’t a quirky divergence—it’s a warning signal. When fewer stocks are doing the heavy lifting but the index pushes higher, it often means the market is being propped up by a shrinking set of large-cap leaders. This narrowing participation is one of the earliest, most reliable signs of a potential market top forming.

In the current cycle, that leadership is concentrated in mega-cap technology names, particularly those tied to artificial intelligence. While price action remains positive at the index level, structural deterioration under the surface suggests traders should proceed with increased caution.

Richmond Lee, CFA and Senior Market Analyst at PU Prime commented:

The recent rise in U.S. equities, especially the S&P 500 and Nasdaq, hides significant internal weakness. While the S&P 500 has reached new highs, fewer stocks are joining the rally. The gains are mainly concentrated in large tech companies like Nvidia, Microsoft, and Apple. This narrowing participation is a common late-cycle signal. It suggests that upward momentum relies on a smaller group of leaders instead of broad market confidence. When just a few stocks drive index performance, the risk of decline increases sharply if those leaders stumble.

Nvidia is central to this situation. Its strong position in the AI chip market has led to exceptional returns, but this concentration makes it vulnerable. A drop in AI spending or increased competition from AMD, along with chip development by Microsoft or Meta, could cause quick weakness—not only for NVDA but also for tech-heavy indices like the Nasdaq 100.

Meanwhile, institutional investors seem to be shifting toward safer sectors like healthcare, utilities, and consumer staples, which suggests a move to reduce risk. Increased volatility in intraday trading and less participation in new highs further indicate that the market might be moving into a distribution phase instead of starting a new bullish trend.

For traders, it’s time to be cautious. The S&P 500 may continue to rise in the short term, but it’s wise to cut back exposure to overextended growth stocks, tighten stops, and keep a close eye on breadth indicators. A drop toward 4,900 to 5,000 on the S&P 500 would not be surprising if the market leadership weakens further.

In the short term, the risk/reward profile for U.S. equities have become unfavorable. Defensive positioning is now the sensible choice.

Narrowing Market Breadth: The First Sign of a Top

Healthy bull markets are broad-based. A rising tide lifts most sectors and stocks. But when gains become concentrated in a handful of names, it indicates fragility. The recent performance of the S&P 500 illustrates this problem clearly. Despite index-level strength, breadth indicators tell a different story.

Only a few tech names—namely Nvidia, Microsoft, Apple, Amazon, Meta, Alphabet, and Tesla—have been responsible for the majority of this year’s gains. Nvidia alone now accounts for nearly 8% of the S&P 500 and more than 12% of the Nasdaq. For passive investors holding index funds, this means disproportionate exposure to a single stock.

Figure — Nasdaq Composite (IXIC): Daily chart.

Figure — Microsoft (MSFT): Daily chart.

Figure — Meta Platforms (META): Daily chart.

Figure — NVIDIA (NVDA): Daily chart.

Charles Schwab’s market commentary recently noted that while strong breadth characterized earlier stages of the 2024 rally, that trend is reversing. “Deterioration in participation while indexes continue rising is a red flag for the bull,” Schwab wrote. This is supported by internal indicators showing fewer stocks reaching 52-week highs, even as the S&P 500 sets new records.

When leadership narrows to this degree, markets become increasingly dependent on a small group of outperformers. This creates significant downside risk if those names falter.

Valuations Are Extended—And Concentrated

High valuations by themselves aren’t immediate causes of corrections. But they reduce the market’s margin for error and increase downside sensitivity to negative surprises. Current S&P 500 valuations are being skewed upward by premium multiples in technology.

According to Morningstar’s November outlook, several sectors are now trading “well into overvalued territory,” led by utilities, which are at a 13% premium despite beginning the year undervalued. Technology stocks are currently trading at a 20% premium to their five-year average—well below 2000-era extremes, but still high relative to history.

Morningstar’s chief U.S. market strategist Dave Sekera noted that premium valuations are “concentrated in just a few names,” contributing to a scenario where the broader market appears more expensive than it truly is. This distorts price discovery and increases risk if earnings disappoint.

Sentiment Is Elevated and Acting as a Contrarian Signal

Investor sentiment has become stretched—a condition that often precedes turning points. When optimism is widespread and conviction in continued gains is high, markets become vulnerable. Any surprise—be it earnings weakness, macro deterioration, or geopolitical tension—can trigger an outsized response.

Schwab analysts emphasize that sentiment extremes typically act as contrarian signals. “Stretched sentiment rarely sustains markets indefinitely. It creates fragility, not resilience,” the firm noted. Traders should be wary when bullish sentiment decouples from fundamental support, as it appears to have done in recent weeks.

The Nvidia Factor: Market Driver or Single-Point Risk?

Nvidia’s meteoric rise is a core component of this market cycle. Its dominance in AI chips has fueled gains of over 1,280% in the last five years, helping to power the Nasdaq and the broader S&P 500. But its size and influence now pose systemic risks.

Figure — PHLX Semiconductor Index (SOX): Daily chart.

Nvidia reportedly derives nearly 30% of its revenue from just two customers—believed to be Microsoft and Meta. This kind of concentration introduces significant revenue vulnerability. If either client pulls back spending or shifts to alternative suppliers, the impact on Nvidia’s top line—and on market sentiment—would be immediate.

Competitive pressures are also building. AMD and Intel are accelerating their AI chip offerings, while large tech firms are developing proprietary silicon to reduce reliance on third parties. Regulatory actions are adding pressure too. U.S. export restrictions have already curtailed Nvidia’s sales to China, a market previously estimated to be worth $50 billion.

In short, Nvidia embodies both the opportunity and the risk embedded in this market. While AI remains a powerful secular theme, current valuations appear to be pricing in near-perfect execution. That leaves little room for disappointment.

Sector Rotation: Smart Money Is Moving Early

Institutional investors rarely wait for top signals to become obvious. Instead, they begin rotating capital away from high-growth sectors toward more defensive areas as soon as market leadership begins to narrow.

That rotation is already underway. Healthcare, utilities, and consumer staples—all traditional safe havens—are attracting renewed flows. These sectors offer stable cash flows, dividends, and lower beta exposure during uncertain periods.

Bill Merz, Head of Capital Markets Research at U.S. Bank, explained that despite a relatively strong macro backdrop, “market volatility has picked up with increased concerns about artificial intelligence spending.” Traders should interpret this as a signal: capital is moving to reduce risk exposure.

This early sector rotation typically marks the second phase of a topping process. It reflects declining risk appetite and mounting concern about valuation and sustainability in leading sectors.

Valuation Compression and Defensive Outperformance

As capital exits richly valued tech names, value stocks—particularly those with strong balance sheets and reliable cash flows—tend to outperform. We are starting to see this. Banks, industrials, and materials names have begun posting relative strength, even as tech leadership weakens.

This trend is often accompanied by a re-rating of growth stocks as forward P/E multiples compress. Traders should monitor earnings reactions closely. In high-valuation environments, even small earnings misses can trigger steep price declines. On the other hand, value names with modest expectations are more likely to outperform.

The outperformance of value-oriented sectors, particularly financials and industrials, is historically consistent with late-cycle behavior. While the rotation may be uneven, it signals a change in leadership that traders should respect.

Volatility Is Rising—and That Matters for Execution

One of the most reliable signs of a market top forming is increasing volatility. As leadership narrows, sector rotation accelerates, and sentiment remains elevated, price swings tend to grow larger and less predictable.

This volatility doesn’t just affect long-term investors—it directly impacts trading strategy. Execution risk increases, gaps become more common, and tight stops can be triggered more easily. Traders should adjust position sizing, tighten risk management protocols, and consider reducing leverage.

Expect volatility to remain elevated as markets digest mixed earnings, uncertain policy guidance, and macroeconomic crosscurrents heading into year-end.

What Traders Should Watch Next

To gauge where we are in the topping process, traders should monitor several key metrics:

• Breadth indicators: Track the percentage of stocks above their 50-day and 200-day moving averages. Deteriorating breadth is a leading signal.
• Sector flows: Watch ETF inflows to defensive vs. cyclical sectors. Sustained rotation signals institutional positioning.
• Valuation spreads: Monitor relative P/E ratios between tech and value sectors. Narrowing spreads suggest momentum is shifting.
• Volatility indexes: Rising VIX levels often accompany distribution phases. Stay alert to intraday spikes.

Figure — CBOE Volatility Index (VIX): Daily chart.

• Earnings reactions: Pay attention to how stocks respond to earnings. Weak reactions in leadership names are a warning.

Market Outlook: Short-Term Bearish with Rising Risks

While index levels may continue drifting higher in the short term, the underlying structure of the market is weakening. Concentrated leadership, elevated valuations, defensive rotation, and rising volatility all suggest that the market is entering a more vulnerable phase.

This is not a forecast for an immediate crash. Markets can remain overvalued and irrational longer than expected. However, the signals now warrant a cautious, tactical approach.

Traders should consider reducing exposure to overextended growth names, increasing allocations to defensive sectors, and tightening risk parameters. Breadth deterioration and sector rotation suggest we are in the later innings of this rally.

Short-term forecast: Bearish bias with rising volatility and defensive outperformance likely.

As the old Wall Street adage reminds us: “The market takes the escalator up and the elevator down.” The warning signs are in place. Being early to reduce risk is better than being late to react.