Nathan Thooft is no market bear. His team at Manulife Investment Management, which oversees $160 billion, still holds a modest overweight in stocks. But as US markets jump from record to record, he’s been trimming big winners, buying bonds and adding a layer of protection with longer-dated options.

“Markets are getting overly complacent,” said Thooft, the chief investment officer of multi-asset solutions at the Boston-based firm. Over the past nine months, his team has steadily reduced exposure to high-yield credit, shifted toward non-US equities, and redeployed capital into safer corners. “We have had a massive rebound since the tariff driven lows in April with limited pullbacks. Valuations are stretched in many markets. Risk indicators have fallen to the lows of the year.”

It’s a calculation many professional investors are wrestling with: how much to hedge in a stock and credit rally that has for years defied predictions of a slowdown. Artificial-intelligence enthusiasm, solid corporate earnings, and an economy that has absorbed the highest interest rates in two decades have kept the rally alive. But inflation pressures haven’t fully receded, and the Federal Reserve has yet to declare victory.

In that gap between optimism and caution, a handful of defensive signals have emerged in recent weeks — a tilt toward more downside protection in equity options, fresh inflows into cash and gold products, and a pullback from leveraged long exchange-traded funds. Bears are outnumbering bulls among retail investors, according to the latest survey from the American Association of Individual Investors, while record 91% of respondents in Bank of America Corp.’s survey say US stocks are overvalued.

Taken together, it all suggests hedged optimism: investors willing to chase returns but unwilling to abandon protection. Even in this improbable peace, Wall Street suspects the rally’s foundations could be tested.

Once again, this week rewarded the optimists. Bets on a September rate cut remained high, the S&P 500 extended its summer rally, and corporate fundraising stayed brisk. Bitcoin surged to records. Global equity funds pulled in $26 billion, led by US large caps, while bond funds added $26 billion. The MOVE Index of bond volatility fell to its lowest since 2022, and the VIX hovered near year-to-date lows.

Garrett Melson, a portfolio strategist at Natixis Investment Managers Solutions, has been adjusting allocations almost twice as often as usual — and, in some weeks, every few days — to fine-tune exposures as markets grind higher. The faster pace reflects not just policy volatility from the Trump administration but the speed of swings in market narratives.

“The direction of travel is that things continue to cool off here and eventually the consensus gets a little too bullish,” Melson said. His team has cut credit risk, added Treasuries, and kept only a slight overweight in technology, which he sees as still benefiting from the AI boom. He sees scope for a 5% to 6% pullback as sentiment runs hot, but doubts a major downturn is imminent. Treasuries, he said, remain a more reliable hedge than gold or commodities, which can fade in a prolonged slowdown.

That balance between chasing gains and guarding against reversals was tested repeatedly in the past week. Bulls celebrated Wednesday after a report showed tame consumer inflation, only to pare bets on imminent Fed rates cuts when wholesale prices jumped a day later. Yields rose and shares slipped again Friday as data showing weakening consumer sentiment blotted out a big jump in store sales.

Those swings kept a thin undercurrent of caution alive — and fed the debate over how much protection to keep in place. A measure of the relative cost of crash protection, skew in the S&P 500, has risen markedly. At the same time, leveraged ETFs with bullish tilts — a favorite tool for speculators — have seen nearly $9 billion of outflows in the past month, according to data compiled by Bloomberg.

The summer rally has sent S&P valuations higher than 22 times forward earnings, well above the 10-year average of around 18. Yet any impulse to hedge must answer to how effortlessly markets have brushed off shocks in recent years. So far, investors have absorbed years of elevated rates, trade frictions, and volatile policies with surprising ease. For allocators like Thooft and Melson, the challenge is deciding how much to respect that resilience, and how much to insure against the moment it gives way.

Not everyone is responding with more trades or more hedges. Julie Biel, portfolio manager and chief investment strategist at Kayne Anderson Rudnick, has not made a single change to her 28-stock portfolio this quarter. She avoids derivatives and instead relies on what she calls “pure blue-blood winners” to carry through bouts of volatility. Investors, she said, have little patience for anything less certain, making the market prone to sharp pullbacks when sentiment shifts.

“FOMO is not the same thing as euphoria,” she said, describing a market dominated by the AI trade, where investors crowd into clear winners. “It means that when you hit a tricky period, everyone runs for the exits fast.”

Written by: Denitsa Tsekova and Isabelle Lee — With assistance from Athanasios Psarofagis @Bloomberg

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