Stocks hover at record highs and bullishness reigns. The hosts on CNBC are more hyperactive than ever.

However, you should always look askance at financial analysts who act like cheerleaders, waving their pom-poms and shouting: “Buy high, sell higher!” The bull market is alive and well, but the story is nuanced. Don’t get complacent.

Despite the rah-rah optimism driving the market to all-time records, I’m starting to view the enthusiasm as a potential contrarian signal.

Below, I’ll explain why there’s still fuel for the bull run, but I’ll also show you how to diversify to achieve a prudent balance between risk and reward.

U.S. stocks reached record highs last week. Concurrently, the global equity market also has soared, with key indices such as the German DAX, the French CAC, and Japan’s Nikkei reaching historic milestones, the latter notably surpassing its previous peak established in 1989 after a span of 34 years.

However, beneath this bullish narrative, I see warning signs. Bond markets have faced renewed pressure stemming from an uptick in interest rates.

The benchmark 10-year U.S Treasury yield (TNX) slipped a bit last week but in recent weeks has been rising and currently hovers near 4.2%. The CBOE Volatility Index (VIX) also has been rising and approaches 14. Both trends pose a headwind unless these indicators reverse course.

Inflation has been falling, but inflation’s path doesn’t rule out a few unpleasant surprises down the road.

The S&P 500 12-month forward price-to-earnings ratio (FPER) has reached 23.4. This valuation exceeds both the five-year average of 19.0 and the 10-year average of 17.7. The tech sector, in particular, has gotten frothy.

To be sure, I think economic and earnings growth are supportive of further equity gains. But many stocks are priced for perfection and they’re vulnerable to pullbacks in the event of bad news.

In stark contrast to previous instances where elevated yields triggered equity swoons, U.S. stocks rose anyway last week, as the following chart shows:

For the month of February, the Dow Jones Industrial Average added 2.22%; the S&P 500 climbed 5.17%; the tech-centric NASDAQ gained 6.12%; and the small-cap Russell 2000 gained 5.3%. Both the S&P 500 and NASDAQ last Friday notched record closes.

The four pillars…

The resilience of equity markets finds support in four key pillars: rebounding corporate earnings; robust economic growth; falling inflation; and persistent enthusiasm for artificial intelligence (AI). The AI craze is catalyzed by the promising outlook of chipmaker Nvidia (NSDQ: NVDA).

Stocks got a lift last week when the U.S. Bureau of Economic Analysis released the personal consumption expenditures (PCE) index for January and the inflation data met expectations.

The economic expansion is further substantiated by the second estimate for fourth-quarter gross domestic product (GDP), revealing a healthy 3.2% growth rate. Despite minor adjustments from initial estimates, consumer spending surged by 3% in Q4, underscoring the economy’s buoyancy.

Additionally, accelerating productivity growth, coupled with minimal jobless claims and a receding tightening in lending conditions, underscore the narrative of sustained economic vigor.

The outperformance of growth-sensitive small-cap stocks and the resurgence of the retail industry index after prolonged stagnation signify growing investor confidence in the sustainability of economic expansion.

February’s performance serves as a testament that equities can thrive amid rising yields, provided they stem from robust economic fundamentals rather than precipitated by Federal Reserve rate hikes.

With most S&P 500 companies having reported Q4 operating results, earnings growth (year-over-year) stands at a commendable 4%, driven by mega-cap technology stalwarts. Looking ahead, cyclical sectors are on track for resurgence as the Fed pivots to rate cuts.

As the Q4 earnings season draws to a close, attention shifts towards economic indicators and the forthcoming March 19-20 meeting of the policy-making Federal Open Market Committee (FOMC).

Offsetting equity gains, investment-grade bonds witnessed a decline in February, propelled by unexpected inflationary upticks and shifting rate-cut expectations. Forecasts suggest a tempered path of inflation, paving the way for Fed rate cuts possibly by June.

But deflation rarely moves in a straight line, especially when high prices have resulted not from textbook conditions but from the disruptions of a global pandemic.

Consequently, as always, be sure to diversify. Opportunities have arisen for portfolio diversification, with a potential extension of fixed-income durations recommended to capitalize on prevailing yield trends.

In the coming months, I expect a broader leadership in U.S. stocks, with compelling buys emerging in value-oriented investments and overlooked small- and mid-cap segments.

The “Magnificent Seven” tech leaders have reached lofty heights. Over the long haul, most of these tech stocks should outperform. But right now, they’re expensive with little room for error. You should rotate into other sectors to achieve “defensive growth.” Health care, real estate, utilities, and cyclicals look appealing to achieve a better balance between risk and reward.

The main U.S. stock market indices took a breather on Monday and closed lower as follows:

• DJIA: -0.25%
• S&P 500: -0.12%
• NASDAQ: -0.41%
• Russell 2000: -0.10%

Tech behemoth Apple (NSDQ: AAPL) fell 2.54% after getting hit with a hefty antitrust fine of more than 1.8 billion euros ($1.9 billion) by the European Union.

The week ahead…

The following economic reports, scheduled for release in the coming days, are the salient ones to watch:

Factory orders, ISM services (Tuesday); ADP employment, Fed Chair Jerome Powell testifies to Congress, job openings (Wednesday); initial jobless claims, consumer credit (Thursday); U.S. unemployment rate and hourly wages (Friday).

The major news will be Powell’s remarks, which Wall Street will parse for clues as to the central bank’s next move on monetary policy.

Congressional hearings as a whole have become farcical lately, as extreme partisanship continues to paralyze Washington. Let’s hope the questions posed to Powell from lawmakers won’t be too combative or obtuse.

We’re also scheduled to hear speeches from other Fed officials throughout the week, delivered at assorted venues. The words of Fed policymakers have the power to move markets. Stay vigilant.

Read This Story: Crypto Bulls Unleashed: SEC Approval of Bitcoin ETFs Sparks Frenzy

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