Five signals that stocks may be entering the ‘death zone’

• Valuations rarely settle at “fair value”. They tend to bounce instead between euphoria and panic – overshooting in both directions
• Right now, five investor sentiment warning signs are flashing: the classic “this time is different” trap, the assumption that top stocks can’t be overpriced, the myth that there are no better assets out there, the mass failure to consider the risks, and the willingness of the crowd to go all-in
• Emotions can drive markets to extremes. So maintain a clear exit plan with stop losses or momentum signals, follow a rule-based strategy to avoid FOMO, and build a diversified portfolio across assets, sectors, and geographies.

One of the biggest risks for mountaineers is the “death zone” – the altitude at which oxygen becomes so thin that even a small misstep can become catastrophic. It’s not just the mountain that poses a challenge – it’s the overconfidence, fatigue, and emotions that can push them to take reckless risks. And that’s what stock investing today is like.

Here are five signs the air may be getting dangerously thin:

1) The ‘this time is different’ trap

Every major market bubble has started the same way – with an innovation that promised to change everything. Railroads, electricity, the internet, and now AI. When there’s no specific historical precedent to apply, investors let their imaginations (and stock prices) run wild, seemingly convinced that this time, sky-high valuations would be justified.

They’re often right about the importance of the tech itself – but wrong about the timing, the winners, and the price tags.

It’s not entirely surprising. Researcher Carlota Perez found that the road to a new technology’s widespread adoption is never smooth. There’s almost always a boom, a bust, and a brutal reality check before the true winners emerge.

Take the internet, for example: the technology transformed everything. But in 1999, investors bet on the wrong companies (hello, Cisco), and when reality hit, the selloff was ruthless. And it’s not exactly an isolated misstep. From the South Sea Bubble to the Nifty Fifty to various crypto manias, the phrase “this time will be different” has generally not ended well for investors.

2) The notion that ‘no price is too high’ for the top companies

Star fund manager Howard Marks said the surest sign of a bubble is when investors believe there’s no price too high for the best companies. That thinking fueled the so-called Nifty Fifty run in US stocks in the 1960s, the dot-com boom in the ’90s, and the housing bubble in the 2000s – and sounds eerily familiar today. Just like International Business Machines Corp (NYSE:IBM) and Eastman Kodak Co (NYSE:KODK) in the mid-century era, or Cisco Systems Inc (NASDAQ:CSCO) and Intel Corp (NASDAQ:INTC) in 1999, today’s Magnificent Seven are being priced as if they’ll dominate forever – with investors expecting record margins, endless growth, and no real threats. History tells a different story – one where disruptors get disrupted, whether by sharper competitors or the next tech wave. Look at it this way: fewer than half of the Nifty Fifty’s “exceptional” businesses are even in the S&P 500 now.

What’s more, it’s not just AI stocks that are booming today: investors have been bidding up “safe” giants like Costco Wholesale Corp (NASDAQ:COST) and Walmart Inc (NYSE:WMT), just like they did with Coca-Cola Co (NYSE:KO) and McDonald's Corp (NYSE:MCD) in the Nifty Fifty era – before their shares fell by half. Great companies don’t just suddenly stop being great, but when investors think no price is too high, that’s generally a red flag.

3) People investing in certain assets because they ‘have to’

Right now, AI stocks aren’t rising purely because of their fundamentals – they’re gaining because investors feel they have no other choice. Bonds? Too boring. Value stocks? The world has moved on. Emerging market assets? Too risky. That leaves a handful of AI giants soaking up all the investment money – and not because they’ve got the most attractive risk-return, but because they’re seen as the only game in town.

Let’s face it: folks aren’t impressed with single-digit returns anymore – recent history has conditioned them to expect 20%+ gains. And when markets are delivering those returns, FOMO takes over, and rational investing takes a back seat.

Even skeptical fund managers may feel forced to buy into the boom just to keep up with benchmarks and avoid getting fired. When an entire market or sector is on fire, few want to be the ones calling it out. As Howard Marks and hedge fund guru Ray Dalio have warned, the late stages of a bubble are when investors stop asking whether something is a good investment and start buying blind, simply because they think they have to. And, you’ve got to admit, that sounds familiar.

4) A ton of optimism and a desire to downplay risks

After a decade of seeing stocks soar, investors now see not investing as riskier than a market crash. Volatility is low, credit spreads are “tight”, and equity risk premia are low – three metrics that suggest that people see very little chance of things going wrong. That could be fine… until it isn’t. With such a thin margin of safety, stocks may have climbed into the financial equivalent of the mountaineers’ “death zone”.

Optimism, then, is only half the problem – the lack of margin for error is the other half. History shows that when markets price in perfection, even small disappointments hit hard. And those letdowns can come not just from obvious risks like inflation or interest rates: they can come from unforeseen or “black swan” events like the arrival of a new, disruptive player. The rise of DeepSeek is just a glimpse of what that could look like.

As famed investor Jeremy Grantham has said: bubbles don’t burst because stocks become expensive – they burst when reality falls short of the dream.

5) The willingness of the crowd to go all-in on stocks

It’s wise, as Warren Buffett has said, to be fearful when others are greedy. And if you want to figure out how much greed is in the market, ignore what people say and instead watch what they do. You’ll see, for example, that investors have never been more heavily allocated to stocks than they are now. When everyone’s already loaded up on stocks, finding new buyers can become more tricky, and the possibility of buyers turning into sellers can threaten to throw off the market’s balance. That’s why, historically, extreme investor positioning has been one of the most reliable signals that future returns will be lower.

I’m not just talking about Wall Street’s humongous banks either: retail investors are more bullish than they were even during the meme-stock frenzy of 2021. Data from JPMorgan shows that mom-and-pop sentiment is at record highs, while Barclays found that individual investor exposure to stocks is near its highest level since 1997. And despite rising uncertainty, they’re still buying big.

Retail traders alone poured over $2 billion into stocks – twice – just last week. A rush that size had happened only nine times in the past three years. Even NVIDIA Corp (NASDAQ:NVDA)’s 17% drop after DeepSeek’s buzzy AI debut barely slowed the rally. Investors didn’t take their profits and run: they doubled down.

And, sure, I get it: buying the dip has been a profitable strategy so far. But with investors already maxed out on stocks and crowded into just a handful of names, the market is running on momentum and confidence. And history suggests that’s when sentiment is at its most fragile.

So, why should you care?

Let’s be clear: I’m not saying AI won’t change the world. Railroads did. The internet did. AI most certainly will do too. And I’m not saying stocks can’t go even higher in the short-term or that you should steer clear entirely – markets tend to overshoot when they believe a new innovation is unstoppable and timing the pop is nearly impossible.

What I am saying is that sentiment’s running so hot it’s pushed valuations into the “death zone” – where a slight misstep could be calamitous. That makes the long-term risk-and-reward balance for US stocks seem shaky. And, in fact, the next decade’s returns are likely to disappoint in a big way.

Because of that, diversification is more important than ever – so consider building a more robust portfolio that brings together investments across asset classes, styles, sectors, and geographies. Here’s a decent starting point.

If, on the other hand, you want to remain all-in on US stocks for now – then, hey, that’s your call. Just make sure you can stomach a big downward move or you put a clear exit plan in place. That means using trailing stop losses, following price momentum signals to let you know when it’s time to hit the eject button, or implementing options strategies to limit your downside. Don’t rely on your gut instinct to tell you when the party’s over – even savvy investors get caught chasing the top.

Remember to manage your behavioral biases too. That could mean using a checklist before making a buy or sell decision, keeping an investment journal to identify the biases that could trip you up, or sticking to a clear, rule-based strategy to avoid getting caught in FOMO or panicking at the worst time.

Stéphane Renevier is a global markets analyst at finimize.

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