FOMO vs. Fundamentals: Retail buys the dip, institutional investors stay cautious

Key points:

• Retail optimism is rising, but institutions are still treading carefully amid lingering macro and earnings risks.
• Policy and fiscal uncertainty remain elevated, with trade tensions, U.S. debt concerns, and a cautious Fed dominating the backdrop.
• Investors need to stay selective and diversified, as sector leadership shifts and valuation risks persist—especially in tech.

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The equity market has quickly moved past tariff and recession fears. The S&P 500 is up over 6% in May so far and in gains year-to-date as well.

The rally is primarily being led by retail investors, as they have been encouraged by recent pullbacks, tariff pauses, resilient tech earnings and diminishing recession fears. However, institutional investors remain on the sidelines—and the growing disconnect between the two suggests it's time for caution, not complacency.

According to Bank of America's May 2025 Global Fund Manager Survey, institutional investors have reduced their underweight positions in U.S. equities to a net 13%, down from 17% in April. This shift indicates a cautious optimism among professionals, contrasting with the more aggressive buying behavior observed among retail traders.

Key risks retail traders may be overlooking

Trade tensions persist

Despite a temporary tariff truce between the U.S. and China, underlying tensions remain unresolved. President Trump's recent frustrations with deal-making and China's renewed scrutiny of U.S. export rules suggest that trade uncertainties could resurface, potentially impacting market sentiment. The trade war narrative may have faded from headlines, but the risk remains real—especially for global supply chains and tech.

U.S. fiscal health remains in question

The U.S. debt downgrade was ignored by equity markets, but the underlying story is troubling. The U.S. is running record deficits with no credible plan for fiscal consolidation. Bloomberg argues that the latest House budget plan would push U.S. debt to 125% of GDP by 2034, even under optimistic assumptions. It relies on budget gimmicks—labeling tax cuts as “temporary” to dodge accounting rules, only to extend them later. With debt surging and real solutions not being prioritised, the risk is rising that markets will eventually demand a much higher premium to fund U.S. deficits.

Global demand for U.S. bonds may shrink

Foreign appetite for Treasuries is waning. Japan’s rising bond yields may encourage capital repatriation from the U.S., while China’s Treasury holdings have fallen to a 14-year low, now below the UK’s. This shift signals structural diversification away from U.S. debt—at a time when supply is surging.

Geopolitical uncertainties

Ongoing conflicts, such as tensions between Israel and Iran, pose risks to global stability. Any escalation could lead to increased market volatility and affect investor confidence.

Supply chain realignments

Geopolitical fragmentation continues to force companies to diversify sourcing. These transitions are expensive and disruptive. Earnings could be vulnerable if these supply chain shifts drag on longer than expected.

Trump’s comments against letting retailers like Walmart pass on tariff costs raise red flags. If companies absorb these costs, profit margins may shrink—and current earnings estimates might not reflect that yet.

The Fed remains in wait-and-see mode

The Fed is watching, not acting. While inflation has cooled, uncertainty remains high. That means rate cuts may not come quickly, and market hopes for easing could prove premature. Higher-for-longer interest rates would challenge stretched valuations—particularly in tech.

Valuation concerns in big tech

Despite recent pullbacks, major tech stocks remain expensive. Questions are arising about the sustainability of AI-driven growth, with companies like Alphabet facing challenges to their search dominance, Apple dealing with supply chain risks in China and India, and Meta's heavy reliance on advertising revenue.

Shifting leadership in the S&P 500

Industrials are gaining traction, overtaking some of big tech’s momentum. Traditionally cyclical, industrials often do well in early expansions—but also peak before downturns. The shift could reflect soft-landing optimism, but that view is vulnerable. If growth slows and the Fed stays on hold, cyclicals may come under pressure.

What can different investors do?

Young or long-term investors

Investors with a long time horizon should continue dollar-cost averaging into globally diversified portfolios. Structural growth themes such as artificial intelligence, semiconductors, and digital infrastructure remain compelling despite market volatility. Adding a small allocation to gold or inflation-linked assets can help hedge against geopolitical or fiscal shocks. Over-allocation to U.S. equities should be carefully monitored and geographic diversification should be considered, especially into undervalued regions like China and Europe where stimulus and relative valuations may offer long-term tailwinds.

Cautious or near-retirement investors

Preserving capital while maintaining some exposure to growth is key for investors approaching retirement. Rebalancing toward income-generating, or defensive and lower-volatility assets can help manage downside risk.

Active investors and tactical allocators

In an environment of shifting sector leadership and macro uncertainty, tactical investors should watch for rotations, maintain cash buffers, and consider assets that can hedge tail risk. Gold and volatility-linked assets may help hedge downside scenarios. Recent shifts toward industrials may create relative value opportunities, while defensive sectors such as utilities, healthcare or consumer staples could be in focus if recession concerns rise. With U.S. equity leadership narrowing and policy uncertainty high, active investors can also explore rotation into European and Chinese equities where macro or policy catalysts may offer opportunities.

Bottom line

Retail traders may be leaning into optimism, but institutional investors are seeing too many unresolved risks. Trade tensions, earnings vulnerabilities, geopolitical flashpoints, supply chain disruptions, expensive valuations, and central bank uncertainty all suggest it’s not yet time to let your guard down.