Consumers are the most bullish they've been on the outlook for stocks since May 2021.
The latest survey of consumer expectations from the Federal Reserve Bank of New York showed the mean perceived probability that stocks will be higher in the next 12 months rose to 40.5% in May, up from 38.7% in April.
The survey also showed consumers' expectations for inflation over the next year fell to 3.2% in May, down from 3.3% in April. Broadly, the New York Fed found households were feeling better about their financial situations, as more respondents reported being "better off than a year ago" while fewer respondents noted they were "worse off."
The upbeat sentiment from consumers comes as stocks are near record highs. The S&P 500 (^GSPC) is up more than 12% this year while the tech-heavy Nasdaq Composite (^IXIC) has risen more than 14%.
An increasingly positive corporate earnings outlook has prompted several analysts to upgrade their year-end S&P 500 targets. The Street-high year-end target for the S&P 500 has moved up to 5,600 from 5,200 at the start of the year.
The enthusiasm raises the question of whether the market is getting frothy. Typically, when Wall Street gets overly bullish, it's often the sign of the peak in a market rally, according to research from Bank of America.
But in a research note on Monday, Bank of America head of US equity and quantitative strategy Savita Subramanian noted that sentiment is "not euphoric." Bank of America's Sell Side Indicator, which tracks Wall Street strategists' recommended allocation to stocks, rose to 55.3% in May, which the bank notes is still "neutral." A reading of 58% or higher would usually be a sell signal.
Others on Wall Street are particularly concerned with what's being priced into the current bull case. Markets currently see about two interest rate cuts this year, largely built on a case that inflation will keep declining throughout 2024. RBC Capital Markets head of US equity strategy Lori Calvasina wrote in a note to clients on Monday her team continues to worry that "market participants have gotten a little too optimistic about the timing of cuts."
Calvasina's model projects the S&P 500 should be at 5,300, given the current consensus views on inflation and economic growth. This is about in line with the roughly 5,341 the S&P 500 opened up at on Monday. The risk, Calvasina notes, is if the inflation story continues to prove bumpy and doesn't play out as well as investors currently hope.
"There is some modest downside risk to the US equity market if the Fed does nothing this year and inflation is stickier than expected," Calvasina said.
In this scenario, Calvasina believes the S&P 500 could fall to 4,900, representing a roughly 8% pullback from current levels.
Josh Schafer is a reporter for Yahoo Finance. Follow him on X @_joshschafer.
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