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US equities face mounting risks as economic cracks widen despite record highs
Rising bankruptcies, consumer debt strain, small business tariff pressures and bubble-like market sentiment raise doubts over the sustainability of Wall Street's rally amid expected Fed rate cuts.
Surface strength masks underlying economic fragility
United States (US) equity markets may be heading for turbulence in the coming months, even as major indexes trade at or near record highs, supported by softer inflation readings and expectations that the Federal Reserve (Fed) will cut interest rates in September.
Nasdaq 100 monthly candlestick chart
Beneath the surface, signs of strain are emerging in both the corporate and consumer sectors, while market sentiment increasingly resembles the euphoric peaks of past bubbles.
The disconnect between market performance and underlying economic fundamentals has become increasingly pronounced, with investors focusing on monetary policy expectations while potentially overlooking deteriorating conditions in key segments of the economy.
This divergence between market optimism and economic reality creates conditions where sudden shifts in sentiment could trigger significant volatility as reality reasserts itself over optimistic projections.
Corporate bankruptcies surge to 15-year highs
Corporate distress is rising at a pace not seen in more than a decade. In the first seven months of 2025, 446 large US companies filed for bankruptcy, the highest year-to-date total in 15 years and already exceeding the full-year counts of 2021 and 2022, when 405 and 373 firms went under respectively.
The breadth of filings across industries signals growing financial pressure, even as headline equity benchmarks continue to climb. This suggests that the benefits of the economic recovery have been unevenly distributed, with many companies unable to adapt to higher borrowing and tariff costs and competitive pressures.
The surge in corporate failures indicates that the higher interest rate environment of recent years has taken a toll on business finances, particularly among companies with weaker balance sheets or those in sectors facing structural headwinds.
These bankruptcy trends could foreshadow broader economic difficulties if the corporate distress spreads to larger companies or systemically important sectors that could affect employment and consumer confidence.
Small businesses also bear the tariff brunt
It is not only large American companies who stand to bear the cost of Donald Trump’s trade war - small US businesses, which account for more than half of the country’s job creation, are also in the firing line.
Figures from the US Chamber of Commerce indicate there are roughly 236,000 small-business importers, defined as firms with fewer than 500 employees. In 2023, these companies purchased more than $868 billion worth of goods from overseas. They now face an estimated $202 billion in annual tariff costs, while also struggling to navigate the complex regulatory requirements tied to the president’s levies - the legality of which remains uncertain amid ongoing court challenges.
The latest White House tariff schedule, with rates ranging from 10% to 50%, has forced many business owners to raise their customs bonds - guarantees purchased from surety providers to ensure the government receives tariff payments, other taxes, and any potential penalties.
Larger corporations typically have the in-house expertise and resources to manage these bureaucratic demands, but for smaller firms the burden is far heavier as they do not tend to have access to the same compliance and forecasting professionals.
Consumer debt reaches unprecedented levels
The consumer, the engine of the US economy, is also showing signs of fatigue. Household debt rose by $185 billion in the second quarter (Q2) to a record $18.39 trillion, up $592 billion from a year earlier.
Mortgage balances surged $131 billion to a record $12.94 trillion, while credit card debt increased by $27 billion to $1.21 trillion, just shy of its all-time high. Student and auto loans each reached new records at $1.64 trillion and $1.66 trillion respectively.
25-year US household debt chart
This official data excludes 'buy now, pay later' liabilities, suggesting the true picture could be even more concerning. With debt loads swelling, questions are mounting over consumers' ability to sustain spending at current levels.
The broad-based nature of debt increases across all major categories indicates that consumers are stretching their finances across multiple areas, potentially creating vulnerability if economic conditions deteriorate or employment softens.
Market behaviour displays late-cycle characteristics
At the same time, market behaviour is displaying the hallmarks of a late-cycle melt-up. Speculation is rampant, mega-cap technology shares are soaring, and valuations are stretching into territory rarely seen in history.
Market concentration is at unprecedented levels, and retail investor enthusiasm is surging in a manner that increasingly mirrors the excesses of the late-1990s Dot-Com Bubble. This type of rally, often detached from underlying fundamentals, has historically proven vulnerable to sharp reversals.
The concentration of gains in a handful of mega-cap technology stocks creates systemic risk, as any significant weakness in these names could disproportionately impact broader market performance and investor confidence.
The next big potential flash point may be Nvidia’s Q2 2026 earnings on Wednesday, 27 August 2025.
Such concentrated market leadership often coincides with late-stage bull markets, where momentum and sentiment drive prices beyond levels justified by fundamental analysis, creating conditions ripe for eventual corrections.
Institutional investors are sceptical
US equity valuations are also coming under scrutiny from institutional investors.
According to Bank of America (BoA) Securities, a record 91% of global fund managers now believe US stocks are overvalued.
Percentage of FMS investors say US equities are overvalued
Paradoxically, capital flows suggest a renewed appetite for American equities, with the recent shift seeing fund managers step back from the eurozone and redirect money into US markets.
This reallocation reflects a resurgence in economic optimism, as fears of a hard landing have been eased by the global economy’s apparent resilience and the limited fallout from tariffs so far. BoA's survey shows the perceived odds of an outright downturn are now at their lowest since the question was first posed more than two years ago. Yet this growing confidence carries its own risk: the more markets lean into the soft-landing narrative, the greater the potential for overheating.
Global economy soft, no or hard landing percentage chart
Sentiment indicators flash warning signals
Adding to the concern, CNN's Fear & Greed Index, although no longer lodged in the 'Extreme Greed' zone as was the case a month ago, underscores the speculative mood driving prices higher. Such elevated readings have often preceded market pullbacks, as sentiment eventually realigns with fundamentals.
The early August sell-off perhaps represents the first nail in the coffin, providing a preview of how quickly market sentiment can shift when optimistic expectations meet disappointing reality.
Historical analysis of sentiment indicators suggests that periods of extreme optimism often coincide with market peaks, as widespread bullishness leaves fewer marginal buyers to drive prices higher.
The recent moderation in sentiment indicators may indicate that the market is beginning to recognise some of these underlying risks, though whether this represents a healthy correction or the beginning of a more significant adjustment remains unclear.
Federal Reserve policy complications
Even with the prospect of easier monetary policy from the Federal Reserve (Fed), the timing and effectiveness of rate cuts in addressing underlying economic imbalances remain uncertain. Lower interest rates may provide temporary support for asset prices but cannot resolve fundamental issues like excessive debt levels or corporate financial distress.
The Fed faces a delicate balancing act between supporting economic growth through lower rates while avoiding the creation of additional asset bubbles or encouraging further risk-taking in already stretched markets.
Rate cuts that come too late may prove ineffective if economic momentum has already shifted decisively lower, while cuts that come too early could exacerbate existing imbalances and create conditions for future instability.
The market's heavy reliance on expectations of Fed support creates vulnerability if policy changes prove insufficient to address underlying economic weaknesses or if the central bank's actions fall short of market expectations.
Investment implications and risk management
Taken together, the combination of mounting corporate bankruptcies, deteriorating consumer balance sheets, and frothy investor sentiment suggests that the current rally rests on fragile foundations.
For investors navigating these complex conditions, understanding both the opportunities and risks becomes crucial for portfolio management and strategic positioning.
The forces underpinning this market may be weaker than they appear, leaving equities exposed to a meaningful correction if confidence falters. While the exact timing of any downturn remains uncertain, the accumulation of warning signals suggests that investors should prepare for increased volatility and potential challenges to the sustainability of current market levels.
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