The Growing Risk of Overbought Markets in a Record-Low Cash Environment

The current equity market environment is marked by a paradox: record-low cash allocations among investors coexist with overbought technical conditions in key indices and crowded positions in high-growth sectors like artificial intelligence. While the transformative potential of AI continues to drive optimism, the interplay of technical indicators, sentiment metrics, and positioning data suggests growing fragility in the bull market.

Overbought Indices and Diverging Sector Momentum

The S&P 500's 14-day RSI of 61.633 as of December 2025 signals a "Buy" signal, reflecting sustained upward momentum. In contrast, the Nasdaq's RSI of 54.581 indicates a neutral stance, underscoring recent pullbacks in the AI sector amid concerns over valuation sustainability. This divergence highlights a broader trend: while the broader market remains resilient, AI-driven segments-dominated by the "Magnificent 7" tech stocks-are showing signs of overbought positioning, with 54% of institutional capital crowded into these names.

Crowding and the "Sell Signal" of Low Cash

Investor sentiment has shifted decisively toward risk assets. Global fund managers now hold a record-low 3.3% of assets in cash, a classic "sell signal" for equities according to Bank of America's 2025 survey. This low cash environment has intensified crowding in high-conviction trades, particularly in AI and tech. For instance, 37% of institutional capital is allocated to AI-related sectors, a level that PGIM analysts describe as the "biggest tail risk" in the current cycle. Such concentrated positioning raises the specter of a self-fulfilling correction, where a single negative catalyst could trigger widespread profit-taking.

Technical and Behavioral Indicators of Excess

The equity put/call ratio, a key gauge of investor sentiment, has fallen to 0.7x-the lowest level in four years-as of late 2025. This imbalance reflects a surge in bullish options strategies, particularly in leveraged ETFs focused on AI and tech. Products like the Leverage Shares +3x Long Artificial Intelligence ETP have delivered outsized returns, fueled by explosive demand for compute infrastructure and enterprise AI adoption. However, this enthusiasm is not without risks. Short interest in AI-focused ETFs, such as the iShares A.I. Innovation and Tech Active ETF (BAI), has spiked by 497.3% year-to-date, signaling growing bearish skepticism.

Fundamentals vs. Valuation Concerns

While AI's long-term potential remains compelling-global AI capital expenditures reached $423 billion in 2025, surpassing 2027 projections-short-term valuation concerns are emerging. Major cloud providers are experiencing slowing free cash flow growth, and key revenue segments for hyperscalers appear to be plateauing due to market saturation according to Morgan Stanley. Despite these challenges, the market continues to price in a future where AI delivers $3.70 in returns for every $1 invested, according to Microsoft-commissioned studies. This disconnect between fundamentals and expectations underscores the speculative nature of current positioning.

Geopolitical Risks and the Fed's Role

Macro risks loom large. A PGIM survey found that 56% of institutional investors view geopolitical tensions as their primary threat, yet one-third plan to increase risk exposure in 2025. This duality-acknowledging uncertainty while doubling down on high-risk assets-reflects a long-term view of volatility as an opportunity. However, the market's reliance on the Federal Reserve to deliver a rate cut as a "safety net" adds another layer of fragility according to the same survey.

Conclusion: A Market at a Crossroads

The current bull market, driven by AI's transformative potential, is entering a critical phase. While the sector's fundamentals remain robust, the combination of overbought technical conditions, crowded trades, and low cash allocations creates a precarious equilibrium. Investors must weigh the long-term promise of AI against the short-term risks of a correction, particularly as leveraged ETF flows and short interest highlight growing market tension. As Morgan Stanley notes, the bull market may be in its "seventh inning," requiring a strategic shift toward large-cap quality and active stock selection to navigate the next phase.