A big bear, or just a plain vanilla correction?

How worried should you be?

During periods of market panic, investors look for a policy put. One question is whether the Fed could come to the rescue of equity investors.

The following chart shows the Fed’s dilemma. In the wake of the latest tariff-induced market flare-up, both the 2-year and 10-year Treasury yields have dropped sharply. The 2-year yield can be thought of as the market expectation of the Fed Funds terminal rate. Right now, it’s penciling in about three quarter-point rate cuts until it’s done. At the same time, the 10-year to 3-month yield spread is inverted, which is a signal that monetary policy is tight and the Fed should cut. The MOVE Index is up sharply, indicating anxiety about rate volatility. As well, the trade war stock return factor, which is the spread between companies with domestic revenue compared to the equal-weighted S&P 500, is up sharply. Most preliminary estimates of the new tariffs show substantial upward pressure on PCE inflation. While the Fed is prepared to look through a one-time increase in inflation, Fed officials want to wait to ensure that rising inflationary expectations don’t become anchored at higher levels. Remember the words of Bank of Canada Governor Tiff Macklem last month: “Monetary policy cannot offset the impacts of a trade war. What it can and must do is ensure that higher prices do not lead to ongoing inflation.”

In other words, the Fed won’t come to the market’s rescue by cutting rates.
 

 

While the Fed is unlikely to cut rates, it could flood the financial system with liquidity should financial conditions become overly disorderly. One real-time estimate for financial conditions is the junk bond financing rate (red and blue lines), which is also an estimate of the equity risk premium for highly leveraged companies. Current junk bond readings have edged up, but market stress levels are not blowing out so much that warrant official intervention.
 

 

To be sure, banking system liquidity is still expanding and plentiful, which should be supportive of equity prices.
 

 

What About a Trump Put?

The elements of Trump’s “Liberation Day” tariff announcement is a signal that President Trump is not focused on the stock market. The rollout of the so-called reciprocal tariffs featured a table of tariff levels charged by individual countries and the level of U.S. tariffs in repose. As the calculations show, the administration did not painstakingly compile tariff levels by individual countries on imports from America. Instead, the calculated tariff rate was the U.S. trade deficit with that country divided by the level of exports to the U.S. From that figure, the administration calculated a tariff rate by dividing that figure in half.

 

Instead of addressing what may be the roots of unfair trade practices, the implicit message of this policy is “get the trade deficit down”. If that’s Trump’s priority, don’t expect a wholescale trade policy pivot in the near future even if the stock market crashes. Trump’s approach to calculating the other country’s tariff rate also puts into the question of the utility of trade negotiations. How can any country expect the U.S. to negotiated in good faith based on made-up numbers, especially in light of Trump’s past record of tearing up past agreements like USMCA?

However, past behaviour has shown that the administration was willing to walk back some of its more belligerent initiatives, and such headlines could spark relief risk-on rallies.The most constructive development has been China’s response. While news of China’s retaliatory tariffs rattled markets last Friday, two olive branches were buried in Chinese announcements that were ignored by the market. First, the tariffs don’t have to be paid for a month, which opens the door to negotiations. As well, China didn’t devalue the yuan in response, which is another conciliatory signal that Beijing wants to negotiate. Lastly, the headline of a 34% retaliatory tariff sounds dire, but U.S. exports to China has been falling for years (red line), which minimizes the effects of the retaliatory tariffs.
 

Exhausted Sellers

 

In the wake of the tariff announcement, Street economists and strategists are all downgrading their GDP growth and earnings expectations while raising their inflation estimates. For investors, the equity outlook depends on the two questions of whether the long-term view of the economy will fall into recession, which tends to deepen bear impulses, and the short-term view of market positioning.

MarketWatch reported that Neil Dutta estimates stocks are already discounting a 90% chance of recession, which may be excessively high and prone for a reversal.
 

 

By contrast, the odds of a recession before 2026 on the betting site Kalshi stands at .63%, which is consistent with the latest JPMorgan strategy team’s revised estimate of 60%.

One constructive development that mitigates against a replay of a Smoot-Hawley 2.0 replay of the Great Depression is non-U.S. countries haven’t shown any propensity to raise tariff barriers against each other.
 

 

In the short run, downgrades in the macro outlook will depress risk appetite. But how much selling is left?
 

One clue comes from the March 2025 BoA Global Fund Manager Survey, which was taken before the sell-off began, shows a sharp pullback in risk appetite and a global institutional stampede out of U.S. equities into non-U.S. markets.
 

 

How much selling is left in the short run?

One way to monitor the fast money de-risking process is the price momentum/high-quality factor pairs, which measures the fund flows of the fast money crowd. Fast money tends to focus on price momentum. By contrast, patient money focuses on high-quality stocks and fundamentals. Different measures of price momentum ETFs against the quality factor ETF shows a downdraft in early March, which is reflective of the first selling stampede and risk manager taps on the shoulder of traders to liquidate holdings, a rebound and further recent weakness that did not make fresh lows. This is a possible indication of the exhaustion of fast money sellers of (mostly) Magnificent Seven names.
 

 

NASDAQ 100 relative performance has become oversold, as shown by the 12-month NASDAQ 100/S&P 500 ratio shows that NASDAQ stocks (black line). While oversold markets can become more oversold, this is a level where they are also ripe for a bullish reversal.
 

 

Another sign of panicked selling can be found in the price of action of gold and gold miners, which sold off sharply Friday as stock prices tanked despite acting well as a hedge against stock market weakness.  I am a long-term gold bull, but recently warned that gold mining stocks were overly extended. European and Chinese equities, which had been a recent destination for a rotation from the Magnificent Seven, also sold off Friday. These are signs that the market is undergoing a forced “sell everything” liquidation phase of capitulation.

The UK’s Daily Mail published a story over the weekend with the provocative headline, “Hedge funds are hit by Lehman-style margin calls as Trump’s 10 percent global tariff kicks in”, though the article had no specific details about the degree of leverage taken by hedge funds, or what funds were in trouble. If there are mass margin calls, expect coordinated global central bank invention to flood the system with liquidity. That would be the Fed Put, ECB Put, BOE Put, and PBOC Put all swinging into action, though the Daily Mail tends to be sensationalistic a similar article appeared in the a Financial Times.

Supportive Sentiment

 

From a sentiment perspective, readings indicate that markets are poised for a relief rally.

The NAAIM Exposure Index, which measures the sentiment of RIAs managing individual investors’ funds, spent a second week below its 26-week lower Bollinger Band. This has been a virtually “can’t miss” tactical buy signal in the entire history of the NAAIM Index. Based on a study period that includes the lead-up to the GFC and the COVID Crash, this model’s buy signals have always resolved in short-term rallies.
 

 

The AAII weekly sentiment survey continues to show readings of extreme fear. Both the bull-bear spread and the level of bearish sentiment are at levels seen at the GFC market crash and the bottoming process in 2022.
 

 

The CBOE put/call ratio has spiked to levels indicating significant levels of fear, and so did the 10 dma of the put/call ratio. The market reaction to China’s retaliatory tariffs may be the final tactical signal of sentiment capitulation that precedes a tactical bottom.
 

 

From a contrarian magazine cover perspective, the latest cover of The Economist is also a sign that Trump is likely to walk back some of the announced tariffs, which would spark a relief rally.
 

 

 

Bear Market Rally Ahead

The stock market is obviously very oversold. The red dots in the accompanying chart shows the history of the S&P 500 when it had a two-day consecutive decline of over 10%. This is extremely rare and, if history is any guide, the market has recovered soon afterwards. To be sure, I argued last week that these historical studies of market behaviour are not useful because we have undergone a regime shift. You will have to make your own decision about whether to trust these studies of market history.
 

 

Three of the five components of my Bottom Spotting Model have flashed buy signals. In the past, two or more simultaneous component buy signals have been good trading buying entry points.
 

 

If and when the relief rally materializes, investors should be prepared for just a bear market rally. When I warned about a long-term sell signal in early February based on negative divergences (see A Long-Term Sell Signal?), I wasn’t anticipating a trade war that could spark a global recession.

From a longer-term perspective the massive increase in S&P 500 hourly volatility is a characteristic of a bear market. The stock market should bottom and bounce in the near future. Just don’t overstay the welcome.
 

In conclusion, the latest Trump tariff announcements have sparked a risk-off stampede. Even though the macro and fundamental backdrop is deteriorating, sellers are becoming exhausted and a relief rally should materialize in the coming week. However, both the top-down outlook and technical structure of the stock market argue for a bear market, and any rally should be interpreted as a countertrend move.

My inner trader continues to be (painfully) long the S&P 500. You play the odds, but sometimes you don’t win. The usual disclaimers apply to my trading positions.

I would like to add a note about the disclosure of my trading account after discussions with some readers. I disclose the direction of my trading exposure to indicate any potential conflicts. I use leveraged ETFs because the account is a tax-deferred account that does not allow margin trading and my degree of exposure is a relatively small percentage of the account. It emphatically does not represent an endorsement that you should follow my use of these products to trade their own account. Leverage ETFs have a known decay problem that don’t make the suitable for anything other than short-term trading. You have to determine and be responsible for your own risk tolerance and pain thresholds. Your own mileage will and should vary.

 

 

Disclosure: Long SPXL