Following October's volatility, the U.S. stock market has experienced another pullback in recent weeks, underscoring its highly frothy state and heightened sensitivity to negative news.

On Wednesday, the decline in risk assets moderated slightly. Earlier, both the S&P 500 and Nasdaq 100 indices recorded their largest single-day drops since October 10. While no single trigger caused the sell-off, traders noted that a series of "overbought indicators" provided an ideal opportunity for profit-taking.

Growing concerns over the narrowing breadth of stocks driving the rally, coupled with increasingly hawkish Federal Reserve rhetoric, have dampened optimism about potential rate cuts. Technical indicators flashing caution signals, alongside warnings from Wall Street CEOs about excessive valuations, have further weighed on sentiment.

"For some time now, the market has been grappling with several inconsistencies," said Rich Privorotsky, a partner at Goldman Sachs Group. "A correction was overdue—the only question is how deep it will go."

One of the most notable market moves involved Palantir Technologies Inc. Despite raising its earnings outlook, its shares fell 8%, as optimism around its AI business failed to offset concerns over the stock's excessive rally. Adding to market unease, hedge fund manager Michael Burry disclosed short positions in both Palantir and NVIDIA Corp.

Over the past six months, historic stock gains have pushed valuations to levels seen during "market manias," making signs of overextension evident. The S&P 500’s forward P/E ratio now stands at around 23x, above its five-year average of 20x, while the Nasdaq 100 trades at 28x—far above its 2022 low of roughly 19x.

"The market had priced in a 'perfect scenario,'" said Alexandre Baradez, chief market analyst at IG Group in Paris. "That’s why any doubts about rate cuts, liquidity, or valuations have such an outsized impact. The same goes for earnings—when expectations are priced to perfection, even strong results like Palantir’s can’t push stocks higher."

Internal market indicators also point to overheating. Since April, the S&P 500’s rally has diverged sharply from its moving averages, with its gap above the 200-day moving average widening to 13% in October—a level historically unsustainable over the past 15 years.

Meanwhile, the index’s streak above the 50-day moving average is the longest since 2011. While these overbought signals don’t guarantee an immediate correction, they highlight the stretched nature of the rally.

Year-to-date, the S&P 500 has hit 36 record highs, the latest on October 28. Yet the rally’s breadth remains unusually narrow—nearly half of the index’s gains in early 2025 have come from just six stocks.

Last week, two trading sessions saw significant anomalies in the S&P 500’s market breadth. On October 28 and the following day, the index posted marginal gains or flatlined, while its Advance-Decline Index—measuring the difference between advancing and declining stocks—plunged into negative territory. Both days ranked among the weakest breadth readings in 25 years.

Thematic forces driving the market remain concentrated in the hottest trades—from AI and quantum computing to Bitcoin and momentum plays—with little concern for stretched valuations.

Beyond the narrow leadership, the market lacks counterbalancing forces. Shorting AI-related capital expenditure stocks appears highly risky, while relative-value trades (such as betting on select outperformers) have proven unwise, with some portfolios already delivering double-digit excess returns over the S&P 500.

Another concern is the overconcentration of U.S. corporate capital expenditure in AI, led by a handful of tech giants, even as smaller firms cut spending.

While corporate earnings remain robust, and ambitious expansion plans and partnerships continue fueling stock gains, signs of slowing profit growth are emerging. Additionally, companies increasingly rely on debt markets to fund investments, adding uncertainty to the capital expenditure narrative.

"The real question is whether there’s an AI bubble, but our research suggests there isn’t—the AI theme isn’t over," said Francois Rimeu, senior strategist at Credit Mutuel Asset Management. "NVIDIA’s order book is full, and industry-wide capex remains massive. Sure, some valuations may be questionable, but AI-related trades still have room to run."