Extreme Bullishness for Equities leads to Small-Cap Rotation, Supportive for Credit Market

Market sentiment remains overly bullish, rendering equities vulnerable to any negative catalyst. The S&P 500 trades at stretched valuations with a forward P/E around 22.5x, well above historical norms, signaling limited upside and downside risk. As BofA shows below, equities are at extreme bullishness indicating an over-bought market.

Q4 2025 earnings reports will arrive over the coming weeks, potentially sustaining momentum if they beat, and vulnerable on misses. Recent GDP data points and macro backdrop will likely surprise to the upside. At the same time, counterbalanced forces are in play with tariff threats, persistent geopolitical risks, and mounting uncertainty around Fed, its independence and policy measures.

Credit markets, on the other hand, appear far less vulnerable: high-yield option-adjusted spreads sit near historic tights (e.g., ICE BofA US High Yield Index), reflecting resilient fundamentals, declining defaults, easy financial conditions and improving growth rates. This benign credit backdrop, with tight spreads offering attractive carry and limited widening risk, is positive for high-yield bonds, leveraged loans, and especially private credit.

Equity markets increasingly recognize this dynamic as evidenced by the Russell 2000 (heavy in smaller, often credit-sensitive firms) that have recently outperformance versus the broader S&P 500, as capital allocators actively rotate towards areas tied to stable credit access during this period of large-cap exuberance and lofty valuations. 

Q: In a world of tight spreads and resilient fundamentals, does private credit quietly offer a better risk-adjusted opportunity than public equities at this stage of the cycle?