(Bloomberg) -- It’s just a quarter of the way through 2021 and stocks have already leaped past Wall Street’s year-end forecasts. They’ve jumped 10% and priced in so much optimism that it will take two more years for earnings to catch up.Is that enough for bulls? Nope. In a market that has plowed through records once every five days, the only things expanding faster than valuations are investor expectations. At Citigroup, an indicator that compares levels of panic to euphoria in the market has been pinned on elation all year, while a Bank of America model weighing optimism among sell-side analysts sits at a 10-year high.To be sure, animal spirits have calmed at the market’s loopiest edge, with penny-stock volume down and the meme craze receding. But robust appetite persists in its tamer -- and still speculative -- districts. And while fortunes would have been sacrificed repeatedly by anyone expecting this rally to overheat, the juxtaposition of stretched sentiment and a still-healing economy is a source of growing anxiety for professionals.“It is strange to see these sentiment measures elevated at the same time the economy is still recovering,” said George Mateyo, chief investment officer at Key Private Bank. “We’ve had a shot in the arm with respect to fiscal and monetary stimulus” and its impact on the economy “is likely to continue for a while longer, but at some point it’d fade.”Not that there aren’t a lot of reasons to stay optimistic, with many data points coming in stronger than expected, vaccine rollouts (mostly) continuing and earnings expected to buttress the bull case. Taking any single sentiment indicator at face value and relying on it as a sell signal could have meant missing out on one of the largest year-over-year rallies ever recorded.Sentiment readings “are hovering at extremely high levels and we could have been worried about them three months ago -- we could have been worried about them one month ago,” Lori Calvasina, head of U.S. equity strategy at RBC Capital Markets, told Bloomberg TV. “They are telling us that the gains are going to be harder to come by, that if we do get negative catalysts, we are vulnerable to the downside. But I think it’s hard to view any of this data as an automatic sell signal right now.”Doubters point to everything from potential Fed tapering and tax hikes to the potential for fatigue among retail investors. A look under the surface already shows a shift in leadership that’s tilting toward companies whose growth is seen as more resilient during an economic slowdown. The frenetic buying of cyclical shares like energy and banks has cooled during the past month. Vaulting back to the top of the leader board are defensive stocks like technology, real estate and utilities.Bank of America’s “sell side indicator,” which aggregates the average recommended equity allocation by strategists, has risen for a third month to a 10-year high. But the cyclical rebound, vaccines and stimulus are all largely priced in already, wrote strategists led by Savita Subramanian. Meanwhile, a record amount of equity funds is being absorbed: Inflows to stocks over the past five months, at $576 billion, exceed inflows from the prior 12 years, according to the bank.Citigroup’s panic/euphoria model, which tracks metrics from options trading to short sales and fund flows, has remained in “euphoric” territory for much of this year, “generating a 100% historical probability of down markets in the next 12 months at current levels,” according to the bank’s chief U.S. equity strategist Tobias Levkovich.Options traders are placing bets the calm won’t last. The middle part of the VIX curve shows many are expecting volatility to pick up, with the spread between the VIX -- the market’s fear gauge -- and futures on implied 30-day volatility four months from now near the highest level in about five years. One trader last week wagered that the fear gauge will rise toward 40, and won’t be lower than 25, in July. The trader appears to have bought a total of about 200,000 call contracts, an amount almost as big as the total daily volume of VIX calls, based on the 20-day average.“Sentiment -- it’s not usually enough on its own to tip a bull market over, but it does mean that if there is something that causes the broad market to flinch, it can sell off quicker and harder,” said Ross Mayfield, investment strategy analyst at Baird. “When sentiment is running this hot, you’re hitting a new all-time high every day, at some point there will be a correction. Paying up for protection, if you have short-term money, makes plenty of sense.”Going all-in on equities for fear of missing out -- while staying protected against any downturn -- is the preferred posture of hedge funds. Lured by an almost uninterrupted rally since November, the industry has boosted their net exposure to equities to multi-year highs. Meanwhile, they’ve stepped up hedging through macro products such as index futures and exchange-traded funds. Their short sales on ETFs, for instance, increased 11% this year through March 26, according to data from Goldman Sachs Group Inc.’s prime brokerage unit.The hedged-long approach has gained traction on Wall Street. On Friday, JPMorgan Chase & Co. strategists led by Nikolaos Panigirtzoglou recommended investors hold on to risky assets such as stocks but add hedges through options in credit and stocks. One looming risk for the market is a continuing retreat from retail investors, a steadfast driver behind the yearlong bull market, they said.“We don’t believe that the equity bull market is yet exhausted,” the strategists wrote in the note. But “there is clear evidence of elevated equity positioning by retail investors and thus a vulnerability for the equity market going forward,” they said.Gene Goldman, chief investment officer at Cetera Financial Group, says his firm is looking for ways to de-risk its portfolios. “People are seeing the recovery, they’re seeing good things happening today, which is great, but it’s a classic case of ‘buy the rumor, sell the news’ and what they should be doing is looking six-to-nine months from now,” he said. “There are many headwinds that are going to hit the market.”For more articles like this, please visit us at bloomberg.comSubscribe now to stay ahead with the most trusted business news source.©2021 Bloomberg L.P.