‘Extreme caution needed’: Why the Wall Street Boom Might End in Bust

In just the past three months, the S&P 500, the U.S. benchmark stock market index, has recorded 25 all-time closing highs. Indeed, equities are defying negative news, showing resilience even as investors contend with multiple headwinds, including a wave of trade tariff increases, downward revisions to jobs data, and the persistent economic uncertainty from the ongoing government shutdown, which has already weakened the U.S. dollar.

Historically, the macroeconomic effects of government shutdowns have been uneven and equity markets have often looked beyond such disruptions, focusing instead on underlying monetary and earnings trends. Given that, the present, record-high level of equity valuations makes the market exceptionally fragile, necessitating caution against any unforeseen negative policy decisions or fundamental surprises. In the face of extremely expensive stocks, Kar Yong Ang, a financial market analyst at Octa Broker, examines whether the rally can endure and what risks traders should oversee.

Valuations at Unprecedented Levels

The U.S. stock market pricing has surpassed the dot-com bubble peak and even pre-1929 levels. The Shiller Cyclically Adjusted Price-to-Earnings (CAPE) ratio, which helps to assess long-term stock market valuations, currently hovers around 38–39, which is more than double the long-term historical average (around 17). This level indicates potentially lower returns over the next few decades.

Even before the 1929 crash, valuations did not sustain such highs. The Buffett Indicator, which compares total U.S. stock market capitalisation to Gross Domestic Product (GDP), has surged above 200% by the end of September 2025. For comparison, it peaked at 150% during the dot-com boom and at 118% ahead of the 2008 financial crisis.

Historically, markets priced at such extremes have delivered either prolonged periods of weak returns or sharp corrections. Weaker-than-expected earnings, reduced liquidity, or sudden macro shocks can trigger a major downtrend. Since the current rally is mostly supported by increased liquidity driven by the Federal Reserve’s (Fed) recent interest rate cut rather than fundamental factors, valuations may significantly drop as the investors’ sentiment shifts.

S&P 500 Futures Weekly Chart

‘From the technical analysis perspective, the summer surge was a huge deal. Breaking past that 6,120–6,170 barrier essentially opened the door straight up to the 6,800 range’, explained Kar Yong Ang, looking at the S&P 500 chart (see above). ‘I think both the big trading algorithms and the fund managers have the 7,000 mark as a key psychological target.

We could easily see a quick push toward, or even slightly above that level, possibly hitting 7,142. But watch out, because a sharp technical pullback is likely from there. Frankly, I wouldn’t bet on this continuous, scary-looking rally. It’s smarter to hunt for quick, tactical opportunities in specific stocks or sectors rather than buying the whole index’.

Risks Beneath the Surface

Although the U.S. stock market remains surprisingly calm after the government shutdown, several economic risks can still trigger sharp corrections in the short term.

1. Liquidity and monetary policy

The conditions when the rally is driven by increased liquidity rather than fundamentals set up fragile market structures. Once the liquidity flows reverse or slow, a sharp correction is inevitable. The Fed’s September decision to lower the interest rate helped fuel the rally by making leverage more affordable. Since investors are almost 100% certain that further rate cuts are to take place in October and December, according to CME FedWatch^[1], the level of liquidity can increase even more.

As monetary policy remains loose, the resulting weakness in the dollar is fueling a massive surge in precious metals, pushing gold to a record $3,970 per ounce (oz) and silver toward its 14-year peak of $48.00 per oz this October. When these metals beat equities so emphatically, it means investors are seeking safety, aggressively hedging against U.S. dollar weakness and expressing widespread scepticism about how long stock valuations can remain at these lofty levels.

In this regard, particularly alarming is the fact that the gold-oil ratio is approaching the levels not seen since Covid-19 pandemic. This ratio, which measures the number of oil barrels that can be bought with a single ounce of gold, has historically been a potent, albeit imperfect, signal of economic crisis and systemic stress.

Kar Yong Ang comments: ‘When crude oil price is falling while gold price is rising, the resulting high ratio between the two commodities implies that the market is preparing for a period of stagflation or a severe deflationary recession, where economic activity stalls [hurting oil] and investor fear skyrockets [boosting gold]. The fact that the ratio is now near its 2020 crisis-era levels suggests a deep lack of confidence in the global economic outlook despite the surface-level strength of the equity market’.

2. Global debt overhang

According to the International Monetary Fund (IMF), public debt levels now surpass those during the pandemic, and they are accelerating faster, especially across the largest economies^[2]. Fifty countries, accounting for 80% of global GDP, drive the increase. For example, Japan’s government debt stood at 216.2%^[3] of nominal GDP as of December 2024. The U.S. recorded 124.3%^[4] in 2024, Italy—135.3%^[5], and France—113%^[6]. In such conditions, governments will struggle to provide adequate fiscal support in case of economic shocks.

Historically, during black swan events like the global financial crisis or the pandemic, governments relied on deficit spending to stabilise economies. Today, however, high debt levels reduce the room for fiscal manoeuvres, with policymakers struggling to provide stimulus or emergency spending to support the financial markets. This increases the risk of a downturn that may evolve into a major economic shock.

3. Waning AI hype and market rotation

Leading tech stocks tied to Artificial Intelligence (AI) infrastructure and cloud computing significantly fueled the stock market rally. The S&P 500 gained nearly 14% year-to-date mostly on AI-related momentum. However, with investors questioning whether such a dynamic is sustainable, the market sentiment shifts. Instead of pure AI stocks, investors consider economic sectors with stronger governmental support, such as infrastructure, defence, and renewable energy^[7].

With the fading AI boom, capital may flow toward cyclical sectors, small-cap equities, and value stocks that typically trade at lower valuations and can benefit more directly from periods of economic expansion. For traders, this poses an opportunity to rebalance their portfolios and elevate risk management with stocks supported by fundamentals rather than speculation.

4. Broader market fragility

This mix of geopolitical and fiscal instability makes the equity market highly exposed to correction risks if external shocks take place. Wars in Eastern Europe and the Middle East continue to unsettle energy markets and undermine geopolitical stability, while recurring budget standoffs in the U.S. and rising debt ratios in Europe undermine fiscal credibility.

Conclusion

U.S. equity valuations are at unprecedented levels, leaving the market vulnerable to shocks. In this case, instead of chasing momentum, traders should adopt a prudent and disciplined approach as part of risk management. It’s best to consider cyclical sectors that benefit from economic rotation or small-cap companies with domestic growth potential to avoid speculative large-cap stocks. Kar Yong Ang concludes: ‘Historically, periods of extreme market valuation are inevitably followed by high volatility. If that happens, a failure to diversify away from large-cap speculation can leave traders painfully exposed’.

Disclaimer: This article does not contain or constitute investment advice or recommendations and does not consider your investment objectives, financial situation, or needs. Any actions taken based on this content are at your sole discretion and risk—Octa does not accept any liability for any resulting losses or consequences.

1. https://www.cnbc.com/2025/09/26/gold-eases-as-strong-us-data-lifts-dollar-inflation-data-awaited.html ↑
2. https://www.imf.org/en/Blogs/Articles/2025/05/29/debt-is-higher-and-rising-faster-in-80-percent-of-global-economy ↑
3. https://www.ceicdata.com/en/indicator/japan/government-debt–of-nominal-gdp ↑
4. https://tradingeconomics.com/united-states/government-debt-to-gdp ↑
5. https://tradingeconomics.com/italy/government-debt-to-gdp ↑
6. https://tradingeconomics.com/france/government-debt-to-gdp ↑
7. https://www.reuters.com/markets/wealth/investors-look-past-ai-hype-long-term-opportunities-government-spending-2025-09-29/ ↑