Navigating the Crossroads: Liquidity Dynamics and Sentiment in Late-Stage Bull Markets

As the 2023–2025 bull market enters its twilight phase, investors face a critical juncture: Should they capitalize on dips in risk assets, or prepare for a potential bear market? The answer lies in dissecting two interrelated forces shaping market dynamics-liquidity conditions and investor sentiment. These factors, when analyzed through historical patterns and current data, offer a nuanced framework for decision-making in an increasingly uncertain environment.

Liquidity Dynamics: The Ebbing Tide of Easy Money

Global liquidity, a cornerstone of bull markets, appears to be peaking. According to a report by Northern Trust, slowing economic growth and tightening monetary policy have led to a "peaking global liquidity" environment, particularly pronounced in the second half of 2025. This shift signals a transition from liquidity-driven gains to a regime where earnings growth and fundamentals will dominate equity performance. For investors, this means that the days of asset prices being propped up by abundant cheap money may be waning.

The implications are clear: risk assets such as equities, high-yield credit, and real estate are likely to face downward pressure as liquidity-driven tailwinds fade. Northern Trust advises prioritizing higher-quality, lower-beta stocks and maintaining a defensive posture through diversification and close monitoring of central bank signals. In this context, "buying the dip" may carry heightened risks if liquidity constraints exacerbate volatility rather than create mispricings.

Market Sentiment: A Contrarian Barometer

Market sentiment in late-stage bull markets has grown increasingly bearish, reflecting a mix of economic policy uncertainty and investor psychology. The Baker, Bloom, and Davis uncertainty index-a widely watched gauge of macroeconomic anxiety-has surged to levels not seen since 2020, driven by geopolitical tensions and the Trump administration's tariff announcements. This pervasive uncertainty has pushed sentiment surveys into bearish territory, with pessimism dominating for months. Historically, such extremes have acted as contrarian signals, often preceding above-average returns over the subsequent six to twelve months.

Further evidence of bearishness comes from technical indicators. The number of stocks trading below their 150-day moving averages has reached "extreme" levels, a pattern that has historically signaled market rebounds. For example, record-low sentiment in early April 2025-the most negative in three decades-correlates with potential inflection points in the market cycle. These dynamics suggest that while the near-term outlook is fraught, pockets of opportunity may emerge for disciplined investors.

However, sentiment is not a monolith. Empirical studies reveal that investor psychology, particularly from social media, amplifies stock price fluctuations, especially in rising markets. In late-stage bull markets, this effect can create self-fulfilling feedback loops, where optimism drives further gains until liquidity or fundamentals intervene. The CSI 300 index, for instance, has shown heightened sensitivity to sentiment-driven volatility, underscoring the role of behavioral biases in asset pricing.

The Interplay of Liquidity and Sentiment

The interplay between liquidity and sentiment creates a complex landscape. As liquidity tightens, sentiment becomes a double-edged sword: it can either cushion markets through contrarian buying or amplify declines during panic-driven selling. The current environment, marked by peaking liquidity and extreme bearishness, suggests a potential inflection point. Yet, history shows that markets often correct before resuming longer-term trends.

For instance, the surge in economic policy uncertainty has historically been followed by above-average returns in three- to six-month windows according to Morgan Stanley's analysis. This pattern implies that while a bear market cannot be ruled out, the market's inherent resilience-driven by contrarian sentiment and central bank interventions-may yet provide opportunities for selective investors.

Strategic Implications for Investors

Given these dynamics, investors must adopt a balanced approach. On one hand, the peaking liquidity environment warrants caution, particularly for speculative assets. On the other hand, extreme bearishness and technical indicators suggest that dips may present entry points for high-quality, fundamentally sound equities.

Key strategies include:
1. Quality Over Momentum: Favor companies with strong balance sheets and consistent earnings, which are better positioned to weather liquidity constraints.
2. Diversification and Hedging: Use derivatives or defensive sectors to mitigate downside risks as volatility rises.
3. Sentiment as a Contrarian Tool: Monitor sentiment surveys and technical indicators for early signs of market bottoms.
4. Central Bank Watch: Stay attuned to policy shifts, as liquidity conditions will remain heavily influenced by central bank actions.

Conclusion

The question of whether to "buy the dip" or "brace for a bear market" is not binary. In late-stage bull markets, liquidity dynamics and sentiment act as twin forces that shape outcomes. While the risks of a bear market are real, history suggests that extreme pessimism and liquidity inflection points often precede rebounds. Investors who combine defensive positioning with disciplined contrarian strategies may find themselves well-placed to navigate the crossroads of this market cycle.