The stock market has been on an incredible rally in 2023, exceeding all expectations. However, there are growing concerns among analysts that this bullish run might be at risk as the market approaches new highs. While the S&P 500 has soared to record levels, driven mainly by the excitement for artificial intelligence on Wall Street, several factors are causing experts to issue warnings of a potential sell-off.

Let’s delve a little deeper to find out why the stock market's gains are in danger and what investors should consider moving forward.

Artificial Intelligence Hype: A Bubble Waiting to Burst?

JPMorgan's top quant strategist, Marko Kolanovic, has raised concerns about the hype surrounding artificial intelligence. He points out that the S&P 500 is heavily concentrated in just seven firms, making up 25% of the benchmark index. This high concentration is a classic indicator of a potential bubble in the market, as quoted on Business Insider, published on Yahoo.

Kolanovic believes that the current macro environment, including the delayed impact of the global interest rate shock, erosion of consumer savings, and geopolitical uncertainties, could lead to market declines and increased volatility. Investors should be cautious about the risks posed by an AI-fueled bubble, as it could be vulnerable to headwinds.

Inflation Looming: A Threat to Market Stability

The article went on to highlight that Wells Fargo's chief global market strategist, Scott Wren, talked about the looming threat of stubborn inflation. Although inflation has cooled from its highs last year, there is still a significant risk that it could rebound due to lingering economic pressures, such as a strong labor market.

If inflation rises again and interest rates increase, the sectors that have been driving the current stock market rally might experience sharp pullbacks. Wren advises that the risk-to-reward tradeoff of entering the market at this point may not be favorable. While he predicts the S&P 500 to end the year higher than current levels, he cautions against underestimating the impact of inflation on market stability.

Rollercoaster Inflation: A Profitability Dilemma

BlackRock, the world's largest asset manager, predicts a period of "rollercoaster inflation" ahead, leading to uncertainty and volatility in the market. High inflation can raise costs for companies, negatively affecting their profits.

Conversely, falling inflation can result in lower prices charged by firms, also impacting profitability.This dynamic makes it difficult to predict how economic news, such as falling inflation, will impact the markets, adding further complexity to the current stock market outlook.

A Familiar Pattern: Comparisons to Past Market Movements

The Business Insider article pointed out that David Rosenberg, head of Rosenberg Research, draws attention to the recent 13-day winning streak in the Dow, which was the longest since 1987. He reminds investors that back in 1987, the Dow experienced significant gains before plummeting 19% later in the year.

Rosenberg dismisses the current stock market uptrend as a short-lived "FOMO-based" rally, where investor sentiment drives prices higher. He cautions that the market may not sustain this exuberance and could experience a flat year or even face declines in the near future.

Proceeding with Caution With These ETFs

Investors should consider diversification and risk management strategies to protect their portfolios from potential downturns.Hence, we highlight a few ETFs that could give protection if the markets turn volatile.

AGFiQ US Market Neutral Anti-Beta Fund (BTAL Quick QuoteBTAL - Free Report)

The underlying Dow Jones U.S. Thematic Market Neutral Anti-Beta Index is a long / short market neutral index that is dollar-neutral. The expense ratio is 1.54%.

Cambria Tail Risk ETF (TAIL Quick QuoteTAIL - Free Report)

The actively-managed Cambria Tail Risk ETF seeks to mitigate significant downside market risk. The Fund intends to invest in a portfolio of out of the money put options purchased on the U.S. stock market. The fund charges 59 bps in fees.

AdvisorShares Dorsey Wright Short ETF (DWSH Quick QuoteDWSH - Free Report)

The AdvisorShares Dorsey Wright Short ETF is actively-managed with an investment focus that involves buying securities that have appreciated in price more than the other securities in the investment universe and holding those securities until they underperform. The expense ratio is 2.77%.

Simplify Tail Risk Strategy ETF

The actively-managed Simplify Tail Risk Strategy ETF seeks to provide investors with a standalone solution for hedging diversified portfolios against severe equity market selloffs. The fund charges 84 bps in fees.

Invesco S&P 500 Downside Hedged ETF (PHDG Quick QuotePHDG - Free Report)

The Invesco S&P 500 Downside Hedged ETF is an actively managed exchange-traded fund that seeks to achieve positive total returns in rising or falling markets that are not directly correlated to broad equity or fixed-income market returns. The fund charges 39 bps in fees.

Simplify Hedged Equity ETF (HEQT Quick QuoteHEQT - Free Report)

The Simplify Hedged Equity ETF seeks to provide capital appreciation by fully investing in an S&P 500 ETF and simultaneously investing in a series of put-spread collars designed to help reduce volatility. The fund charges 53 bps in fees.

(Disclaimer: This article has been written with the assistance of Generative AI. However, the author has reviewed, revised, supplemented, and rewritten parts of this content to ensure its originality and the precision of the incorporated information.)