Page 2 – Humble Student of the Markets

Why the market won’t crash from here

Posted by Cam Hui - March 16, 2025

Preface: Explaining our market timing models

We maintain several market timing models, each with differing time horizons. The “Ultimate Market Timing Model” is a long-term market timing model based on the research outlined in our post, Building the ultimate market timing model. This model tends to generate only a handful of signals each decade.

The Trend Asset Allocation Model is an asset allocation model that applies trend-following principles based on the inputs of global stock and commodity prices. This model has a shorter time horizon and tends to turn over about 4-6 times a year. The performance and full details of a model portfolio based on the out-of-sample signals of the Trend Model can be found here.

My inner trader uses a trading model, which is a blend of price momentum (is the Trend Model becoming more bullish, or bearish?) and overbought/oversold extremes (don’t buy if the trend is overbought, and vice versa). Subscribers receive real-time alerts of model changes, and a hypothetical trading record of the email alerts is updated weekly here. The hypothetical trading record of the trading model of the real-time alerts that began in March 2016 is shown below.

The latest signals of each model are as follows:

Ultimate market timing model: Buy equities (Last changed from “sell” on 28-Jul-2023)
Trend Model signal: Neutral (Last changed from “bullish” on 15-Nov-2024)
Trading model: Bullish (Last changed from “neutral” on 28-Feb-2025)

Update schedule: I generally update model readings on my site on weekends. I am also on X/Twitter at @humblestudent and on BlueSky at @humblestudent.bsky.social. Subscribers receive real-time alerts of trading model changes, and a hypothetical trading record of those email alerts is shown here.

Subscribers can access the latest signal in real time here.

A Confirmed 5% Canary Warning

The S&P 500 flashed an Andrew Thrasher 5% Confirmed Canary warning last week, which is defined as “the underlying index declines 5% within 15 days from its 52-week high, and closes under 200 dma for two consecutive days”. The signal is based on a research paper that won the 2023 Charles Dow Award.

If history is any guide, subsequent drawdowns have been higher than average (green bars).

Does this mean it’s time to assume a position of maximum defensive portfolio positioning?

At a Crossroad

Regular readers know that I turned intermediate-term cautious on U.S. equities in late January, and the stock market has declined since then. What happens now?

In the short term, the S&P 500 could be regarded as at a crossroads. The index breached a rising trend line while the 5-week RSI was oversold. Investors saw a similar fake-out before in October 2023. Will stock prices recover, as they did in 2024, or is this the start of a significant decline?

It is said that history doesn’t repeat itself but rhymes. Here is a highly speculative template for the possible path of the S&P 500 based on its market action in 2023. I copied and pasted the highlighted portion of 2023 bear market into 2025. I aligned the 5-week RSI readings (top panel) so that the readings are similarly oversold. The S&P 500 was fitted to appear like early 2023 when the S&P 500 dropped sharply and the 40-week moving average, which is roughly equivalent to the 200 dma, were aligned together.

The exact trajectory of the stock market in this projection is pure fantasy, but it does provide a template for the rest of 2025. Here is my base-case scenario against the backdrop of my intermediate-term cautiousness. The most likely S&P 500 path for 2025 is a relief rally that falls short of the old highs, followed by a choppy decline into H2. Expect several volatility events during that time frame characterized by steep drops and rip-your-face-off rallies.

Exhausted Bears

Sentiment models are supportive of a relief rally rather than a market crash from these levels. While sentiment indicators should be regarded as condition indicators and not actionable trading indicators, they are nevertheless useful in determining upside and downside risk and reward. In the absence of further unexpected shocks, current conditions should put a floor on stock prices.

Consider, as an example, the Fear & Greed Index, which is showing signs of extreme fear. Stock prices just don’t crash with sentiment at these levels.

The AAII weekly sentiment survey showed that bears stayed at about the 60% level for a third week, which is indicative of retail panic and contrarian bullish.

From an anecdotal perspective, portfolio manager Steve Deppe also reported a sense of blind panic in his client base.

As well, I had been watching for a spike in the put/call ratio as a sign of panic, even though the 10 dma had been elevated. I finally saw it late last week, but is it enough?

For the last word in contrarian sentiment, I offer the latest cover of The Economist.

A Momentum Unwind

An analysis of risk appetite indicators yields some clues to the nature of the latest pullback. The relative performance of junk bonds roughly tracks the S&P 500 (green line), while the high beta/low volatility ratio (red line) has plunged. I interpret the relative performance of junk bonds as a sign that financial conditions are not overly stressed. Instead, the downdraft was the result of a price momentum and high beta unwind of a crowded long positioning in the Magnificent Seven.

There are constructive signs that the price momentum factor unwind is bottom. The relative performance of different price momentum ETFs are all showing signs of reversal.

In conclusion, I am intermediate-term cautious about the stock market based on continuing signs of weak breadth. In the short run, however, sentiment has become overly bearish and the price momentum unwind that sparked the latest downdraft seems to be abating. My base case calls for a short-term relief rally, followed by a choppy decline into H2 2025.

My inner trader remains long the S&P 500. 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

What are the odds of a Trump recession in 2025?

Posted by Cam Hui - March 15, 2025

It’s an old political trick. Engineer a recession in your first year and blame it on the previous occupant of the White House. Then take credit for the subsequent recovery.

President Donald Trump and Treasury Secretary Scott Bessent recently rattled the markets with the same message of short-term pain for long-term gain. Bessent began with a CNBC interview outlining the Trump Administration’s intent to shift the source of economic growth from the public to the private sector. He added, “The market and the economy have just become hooked. We’ve become addicted to this government spending, and there’s going to be a detox period.”

In a separate interview, Trump said “a little time” may be needed for his tariff plan to start returning wealth to Americans. He acknowledged that the U.S. economy will undergo some short-term pain and declined to rule out a recession this year: “I hate to predict things like that. There is a period of transition because what we’re doing is very big.” Even more alarming to equity investors, he revealed that he wasn’t as concerned about the stock market as he had been during his first term in office: “Look, what I have to do is build a strong country. You can’t really watch the stock market. If you look at China, they have a 100-year perspective.”

So long to the Trump Put.

Could this “detox period” result in a recession in 2025? This matters because, as Callum Thomas observed, non-recessionary pullbacks tend to be short and shallow, while recessionary bear markets tend to see drawdowns last longer and deeper.

Here is what I am watching.

What to Watch: Business Confidence

Let’s start with the good news, I wrote last week that my current forecast does not call for a recession (see Tops Are Processes). My long-leading economic indicators can be broadly grouped into three categories. The consumer and household indicators look a little wobbly. However, the corporate sector remains healthy, and so are financial conditions. The combination of these factors doesn’t point to a recession right now.

What could change that forecast?

Let’s start with the corporate sector. Trump’s on-again-off-again tariff policy has shaken business confidence and made it difficult for corporate executives to plan, which puts downward pressure on capital expenditures and hiring.

The NFIB monthly small business survey is an especially effective window into business confidence. Small businesses are important barometers of the economy as they lack bargaining power, and most small business owners are small-c conservatives who have historically supported Trump in the past. The latest readings show that small business optimism has receded since the election.

On the other hand, uncertainty has risen to nearly all-time highs.

More ominously, prices have ticked up, indicating rising inflationary pressure.

When asked if this is a good time to expand, small business owners’ outlook deteriorated sharply after a post-election euphoric surge.

The Transcript, which monitors company earnings calls, summarized the latest mood as heighted uncertainty:

Capital markets have hit a patch of volatility thanks in large part to volatile policy shifts from the Trump administration. When things change in an instant, it makes it hard to plan for the longer term. Confidence appears to be thinning among both business leaders and consumers. Meanwhile, Jerome Powell sees no reason to rush anything.

Surveys of CEO confidence in big business has also shown a similar reversal in confidence.

While these developments are concerning, there is no need to reach for the alarm button just yet. Monitor the evolution of earnings estimates, which are still rising, and the forward P/E, which has declined to just above the 5-year average.

While bottom-up aggregated forward 12-month EPS estimates are rising, there are some concerning developments from a top-down perspective. Historically, top-down strategists are quicker to react to changes than individual company analysts, who don’t change their estimates until they can fully quantify the effects of macro shocks.

Super-bull strategist Ed Yardeni, who had a S&P 500 target of 7,000 by year-end, pulled back on the odds of his “Roaring 2020s” scenario of a resilient economy and improving productivity, and raised the odds of a flash crash this year. Yardeni also reduced his year-end S&P 500 price target by maintaining his earnings estimates, but cut the forward P/E multiple owing to the “the potential stagflationary impact of the policies [of] Trump 2.0”. MarketWatch also reported that Goldman Sachs strategist downgraded their S&P 500 forecast based on a small cut to earnings estimates and a cut to the expected P/E multiple because “slower growth suggests lower valuations on a more sustained basis”.

I interpret these as early warnings of a deterioration in corporate profits conditions and falling business confidence. From a big picture perspective, corporate profits have been rising as a percentage of GDP (red line) while labour compensation (blue line) has been falling since the COVID Crash. It’s difficult to see how much upside there is in the corporate profit share in light of its already historically elevated condition without triggering social unrest.

It’s still an open question, however, whether these developments are enough to push the economy into a recession, or just a slowdown.

What to Watch: Financial Conditions

The other set of factors to watch are financial conditions. Financial conditions are neutral to easy at the moment. Even though the Fed has signaled that it is prepared to be patient on making a decision to cut rates, the market is penciling in three quarter-point rate cuts in 2025.

More importantly, inflationary expectations are well-anchored. The 5-year breakeven rate derived from the bond market is elevated, but within historical ranges.

High yield financing costs, which is a real-time estate of the equity risk premium, are not showing signs of stress.

In conclusion, the market’s risk appetite was recently dented by a heightened fears that Trump is engineering a recession. My analysis of current economic conditions shows low recession risk and my base case calls for a growth scare. If I had to guess, I estimate recession odds at one in three. I will continue to monitor the evolution of changes in business confidence and financial conditions to measure future slowdown risk.

The anatomy of a pullback, a trader’s perspective

Posted by Cam Hui - March 12, 2025

Mid-week market update: Everyone calm down. It’s not the end of the world. A clear-headed approach is to analyze the roots of the pullback from the perspective of the positioning of different market participants. How each reacted, and what might come next.

First, U.S. equities were overvalued. It just needed a bearish catalyst.

Here’s what happened next.

What happened?

From a trader’s perspective, the news flow was just an excuse The downdraft was mainly a price momentum unwind.

Easy come, easy go. Price momentum was mostly concentrated in the Magnificent Seven names.

Much like the metaphorical butterfly flapping its wings in Tokyo, the unwind was exacerbated by a surge in Japanese bond yields. The combination of rising JGB yields and falling Treasury yields put upside pressure on the Yen. A falling yield spread caused a disorderly risk-off episode and unwind of the Yen carry trade, in which investors borrowed in Yen and bought USD assets, in mid 2024. In light of the strong price momentum of the Magnificent Seven, some of the carry trade funds probably went into U.S. equities instead of Treasury assets. The combination of rising JGB yields, nervousness over an extended U.S. equity market, and trade war fears probably sparked a rush for the exits.

Goldman’s prime brokerage arm reported that hedge funds had been selling equities in size.

The buyers during this period of hedge fund liquidation were retail investors. We can see some of those effects from the AAII weekly sentiment survey. Sentiment remained sanguine in the early part of 2025, but panicked in the last two weeks as the selling accelerated.

What’s next?

What happens now? MarketWatch reported that a team at JPMorgan concluded last week that the momentum unwind is mostly complete, but qualified that conclusion with “if this a ‘structural regime change’ then the drawdown has further to go, with a potential pullback of 25% relative to the market”. In case you didn’t catch that, “structural regime change” is code for Trump-related policy disruption and uncertainty.

That’s another way of saying that the market should bounce under normal circumstances, but oversold markets can become more oversold. Indeed, the S&P 500 has breached its rising trend channel as the 5-week RSI has become oversold. The bulls need to mount a strong defense while the bears need more negative newsflow for stocks to continue falling.

What now? According to William O’Neil, investors are undergoing a “bad news panic market”. We just need to bad news to stop to start the relief rally.

Today’s softer-than-expected CPI report was a constructive development for a rally. However, I am inclined to reserve judgment until the S&P 500 breaches its 5 dma. Until then, the bears should be considered to be in control and this is a “sell the rips” tape. Let’s see if we can get bullish follow-through in the next few days.

My inner trader is still long the S&P 500 and he recently added to his position. 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

High drama at the 200 dma

Posted by Cam Hui - March 9, 2025

Preface: Explaining our market timing models

The latest signals of each model are as follows:

Ultimate market timing model: Buy equities (Last changed from “sell” on 28-Jul-2023)
Trend Model signal: Neutral (Last changed from “bullish” on 15-Nov-2024)
Trading model: Bullish (Last changed from “neutral” on 28-Feb-2025)

Subscribers can access the latest signal in real time here.

A test of the 200 dma

The S&P 500 fell last week to test support at the 200 dma. Many elements of a tactical bottom are there, but not all. The 5-day RSI exhibited a bullish divergence and so did the 52-week highs-lows spread. The VIX Index is trading above the upper end of its Bollinger Band, indicating a deeply oversold condition. The only question mark is the lack of an oversold reading on the percentage of S&P 500 above their 20 dma (bottom panel).

Nearing a short-term bottom

Most of the elements of a short-term bottom are in place.

Take, for example, the AAII weekly sentiment survey. I was surprised when the percentage of bears spiked to 60% two weeks ago. The latest week’s update showed a minor pullback in bearish sentiment, but readings remain elevated. These levels of sentiment are consistent with past short-term market lows.

Similarly, the term structure of the VIX is inverted, indicating high levels of fear (bottom panel) and the VIX Index is above 20. Such episodes of term structure inversions and high VIX in the last year have seen the S&P 500 resolve with short-term relief rallies.

A sense of panic may be setting in, as hedge funds have been dumping global equities at the fastest pace in history in the last two weeks, according to Goldman Sachs prime brokerage.

As the equity liquidation has been global, and the U.S. has recently lagged global stock markets, a momentum-based analysis suggests that the selling pressure was mostly concentrated on the U.S. stocks.

The one question is the put/call ratio. The 10 dma of the equity put/call ratio has reached levels where the S&P 500 has made short-term bottoms in the last year, but it hasn’t shown one or more single-day spikes consistent with panic sell-offs. Does sentiment need one final flush?

Here’s a plausible explanation for the lack of panic in the equity put/call ratio and the relatively elevated level of the percentage of S&P 500 above their 20 dma. The recent selling pressure has been concentrated in the Magnificent Seven, and breadth in the rest of the S&P 500 has been holding up well, though small caps have been weak. It’s an open question whether the S&P 493 has to fully capitulate before a short-term bottom can be made.

A de Gaulle or Liz Truss moment?

There are two obstacles to a relief risk-on rally.

The first and less well-known reason is a bond market tantrum, sparked by the news out of Germany that incoming Chancellor Merz has secured agreements with governing partners to a a €500 billion infrastructure fund and increased defense spending of at least €100 billion per year that are exclusions from the German fiscal debt brake. In addition, German federal states, which were required to balance their budgets, are now allowed to take out debt equal to 0.35% of GDP. The prospect of a flood of debt supply was enough to cause a surge in German yields, and even pushed Treasury yields upwards.

The transatlantic relationship break is becoming very real. Even French President Macron opened the door to extending the French nuclear umbrella to the rest of the European Union. It’s possible that these developments represent both a de Gaulle moment of independence from America in a geopolitical perspective and a possible Liz Truss bond market tantrum moment from a financial market viewpoint.

Trade war uncertainty

The other more visible source of volatility is Trump’s on-again and off-again trade war. Here is just the timeline from last week:

Tuesday: Trump announces a 25% tariff rate on Mexico and Canada
Wednesday: Trump exempts the auto industry for one month.
Thursday AM: Trump exempts most Mexican imports until April 2.
Thursday PM: Trump exempts most Canadian imports until April 2, but insults Canadian Prime Minister Trudeau.
Friday: Trump threatened immediate reciprocal tariffs on Canada.

Treasury Secretary Bessent also defended Trump’s trade policy by stating: “Access to cheap goods is not the essence of the American dream.” More disturbing for equity investors is his allusion to the elimination of a Trump Put: “Wall Street’s done great, Wall Street can continue doing well. But this administration is about Main Street.” (via CNBC)

The high level of uncertainty is reflected in the volatility of my “trade war factor”, which has been in a steady uptrend since the election, but began to trade sideways in a very choppy manner in late January.

All systems (almost) ready

Cutting through all the news-driven noise, I believe the stock market is poised for a relief rally, though it may be in need of a final sentiment flush.

Three of the five components of my tactical Bottom Spotting Model flashed buy signals last week. In the past, two or more simultaneous buy signals were sufficient for short-term bottoms. As previously discussed, the VIX Index rose above its upper Bollinger Band and the term structure of the VIX has inverted. In addition, the NYSE McClellan Oscillator reached an oversold level.

Here’s the weekly S&P 500 chart for a longer-term perspective. The index is now testing rising trend-line support while the 5-week RSI is oversold. Either the market bounces here or prices crack and stock prices enter a more serious bear phase.

I believe short-term conditions are sufficiently oversold to warrant a relief rally. Traders need to be a bit more patient.

My inner trader is maintain his long position in the S&P 500. 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

Tops are processes

Posted by Cam Hui - March 8, 2025

I sounded a warning in late January about a possible long-term market top, based on a negative divergence of the 14-month RSI. It wasn’t a “sell everything” signal, but a cautionary sign of a topping pattern.

It is said that “bottoms are events, but tops are processes”. That’s because market bottoms tend to be formed during panic events, while topping patterns tend to be longer-term drawn out. Here is a review of technical and macro backdrop supportive of my topping thesis.

Negative divergences

From a technical perspective, here is what a negative breadth divergence looks like. Even as the S&P 500 made a new high in February, every version of the Advance-Decline Line topped out in late November and never recovered. Even worse, the 10 dma of the NYSE 52-week highs-lows topped out last September and it’s been slowly declining ever since.

A review of the point and figure charts of the major U.S. stock market averages using a 3% box and 1-box reversal reveals a bifurcated market that’s consolidating sideways and breaking down.

The most constructive chart is the S&P 500, which remains in an uptrend.

The equal-weighted S&P 500 is starting to consolidate sideways and may have broken support.

The NASDAQ 100 is also consolidating sideways and testing trend line support.

The Magnificent Seven ETF (MAGS) has violated trend line support and it’s now breaking down.

The small-cap Russell 2000 is exhibiting a similar violation and breakdown pattern.

Fiscal headwinds

Notwithstanding the technical patterns of a possible topping market, U.S. equities face a number of macro headwinds.

If history is any guide, the first year of a Republican administration is not good for equities, particularly in the second half of the year.

While the market initially focused on Trump’s pro-growth policies of extending the TCJA tax cuts, corporate tax cuts and deregulation, it also faces the downside risk of fiscal contraction from the DOGE-related government layoffs and cuts to government spending. Keep in mind that the TCJA extension represents the fiscal status quo and is not fiscally stimulative. On the other hand, government cutbacks is fiscal contraction, which represents a growth headwind.

Strategist Jim Paulsen pointed out that fiscal contraction is bearish for equity earnings. Treasury Secretary Scott Bessent confirmed that fiscal retrenchment is a policy of the Trump Administration in a CNBC interview: “The market and the economy have just become hooked and we’ve become addicted to this government spending and there’s going to be a detox period” as the economy goes through a “transition from public to private” investment.

Trade war headwinds

Setting aside the fiscal headwinds, I haven’t even begun to address the fallout from a global trade war. It’s impossible to fully forecast the economic trajectory of Trump’s trade wars, as the situation has been fluid. The market initially didn’t take Trump seriously and interpreted his tariff threats as bargaining, but investor mood pivoted to risk-off as the threats became more concrete.

Consider, for example, the effects of the trade war on the U. S. farm belt. Trump acknowledged during his State of the Union speech that tariffs on Canada, Mexico and China might hurt American farmers, saying that there “may be a little bit of an adjustment period.”

An article in Canada’s Globe and Mail revealed Canada’s secret weapon in its trade war – potash, which is used by American farmers as fertilizer.

More than 80 per cent of the potash used by U.S. farmers comes from mines in Saskatchewan. Canada is the king of potash. It possesses the largest potash reserves in the world – by a fat margin – and the largest production by volume. The U.S. cannot source most of its potash from elsewhere. Just two other countries have large potash reserves – Russia and Belarus – and these operations are significantly smaller than Canada’s and prone to geopolitical instability.
In economists’ terms, potash demand is largely inelastic. Potash prices can swing widely, but U.S. farmers have to buy roughly the same amount every year.

At the time of this writing, Trump imposed a 25% tariff on imports from Canada, with a 10% rate on energy, though the tariff on autos was delayed for a month. He also imposed a total of a 20% tariff rate on imports from China. China has retaliated with tariffs on U.S. agricultural products: 15% on chicken, wheat, corn and cotton; and 10% on soybeans and other items. Further, the Chinese embassy in Washington issued a statement: “If war is what the U.S. wants, be it a tariff war, a trade war or any other type of war, we’re ready to fight till the end.”

On top of that, Trump’s termination of USAID’s programs has deprived American farmers of a source of demand. One component of American foreign aid has been to buy U.S. agricultural products and send them overseas, and those purchases have evaporated.

Rising input prices and collapsing demand. You can imagine the consternation in the U.S. farm belt, which largely voted for Trump, to his “little bit of an adjustment period” for the agricultural sector. Under the circumstances, it’s not a surprise that Trump is considering a carve-out for tariffs for the agricultural sector. The market was later relieved when the 25% tariffs were delayed for all USMCA-compliant products until April 2, and Trump acquiesced to a 10% tariff rate from 25% for Canadian potash. In other words, the trade war with Canada and Mexico has been suspended for another month.

All that drama. What was the point? That’s just one corner of the trade war. I haven’t even covered the issue of Mexican retaliation or the impending trade war with the European Union.

It’s not a surprise that tariff uncertainty has served as a brake on capital investment plans and raised input cost expectations, which will create headwinds for economic growth.

The silver lining

Despite all of the dire technical and macro backdrop, the silver lining to this dark cloud is there is no recession in sight, barring an active effort by the Trump Administration to engineer a recession to achieve its stated objective of bringing down the 10-year Treasury yield. As recessionary bear markets tend to be a far more vicious variety associated with drawdowns of up to 50%, my base case calls for a mid-cycle reset of growth expectations and a milder pullback.

Two of the three categories of long leading indicators, which are designed to spot a recession a year in the future, are not signaling a slowdown. The first category of financial and monetary conditions is still relatively easy. The yield curve is upward sloping, indicating expectations of economic growth.

Financial conditions, as measured by the Chicago Fed National Financial Conditions Index, are still easy.

Money supply growth is still positive, and on only two other occasions has money supply growth failed to turn negative at least a year before a recession.

The second category, the corporate sector, appears to be healthy.

Corporate profits are rising. Corporate profits have peaked at least one year before the next recession eight of the last 12 times, one of the misses being the 1981 “double-dip”.

Forward-looking S&P 500 EPS estimates have also resumed climbing after a brief hiccup.

Corporate bond yields have usually made their most recent low over one year before the onset of the next recession, and they are showing few signs of stress.

Here is the bad news. The consumer and household sector is under stress. Real retail sales has peaked one year or more before the next recession about half of the time, and they peaked in 2021.

Housing is considered by most economists to be the most cyclical part of the economy, and housing starts are weak.

In conclusion, a review of the market’s technical conditions and macro backdrop is supportive of a long-term stock market top. The good news is, in the absence of an active policy to engineer a slowdown, there is no recession in sight. My base case calls for an adjustment of growth expectations and a garden-variety bear market, which typically sees a drawdown of 20–30%.

From a shorter-term perspective, Callum Thomas found a distinctive conditional seasonality for the popular Wall Street adage “sell in May and go away”. The six months starting in May perform far more poorly during bear markets than bull markets, which may be the case in 2025.

A guide to market bottoms, and what kind

Posted by Cam Hui - March 5, 2025

Mid-week market update: The S&P 500 fell yesterday and briefly kissed its 200 dma while flashing a positive divergence on the 5-day RSI. Was that the bottom?

Here is a lesson on how to spot market bottoms, and a review of bottom spotting indicators.

Condition indicators

First of all, RSI divergence are condition indicators and not actionable swing trading indicators. They indicate that a bottom (or top) is near, but the bottom (or top) can take time to develop. I use them to exit position. For example, if I were short the market, a positive divergence would be a signal to cover my short. Even though there may be more downside, I have learned to take profits early and not become overly greedy.

Sentiment indicators are generally regarded as condition indicators. MarketWatch reported that traders had stampeded into VIX call options, which is contrarian bullish. While this does describe a sentiment condition, timing the turn using sentiment indicators can be tricky.

Similarly, NDR short-term sentiment is at an extreme reading, which is a contrarian bullish condition. It’s useful if you are under-invested and if you use it to add to your positions, but don’t try to use it for exact market timing.

Sentiment as trading signals

Sometime sentiment indicators are so extreme that I sit up and take notice. In the past, I have found that whenever the NAAIM Exposure Index falls below the lower band of its 26-week Bollinger Band, it’s an actionable buy signal that durable for several weeks. (This signal has not been triggered and readings are neutral).

The term structure of the VIX can be a useful trading indicator. I have found that whenever the 1-month and 3-month VIX term structure inverts, a market bottom is near. That’s why this is one component of my Bottom Spotting Model.

Put volume on SPY spiked to its third highest level yesterday, indicating unbridled panic. That’s another signal that a market bottom is near.

Bottom Spotting Model

Let’s review the components of my Bottom Spotting Model, which is a mix of oversold and sentiment models with different time horizons.

VIX Index: VIX rising above its upper Bollinger Band (triggered). This is an indication of a short-term oversold condition.

VIX term structure: Inverted (see above discussion).

NYSE McClellan Oscillator: Fell to below -50, which is a short-term oversold condition that usually leads to a bounce.

TRIN: When TRIN spikes above 2 at the end of the day, it’s an indication of price-insensitive selling, otherwise known as a margin clerk (or risk manager) market. Such events usually occur at the end of sell-offs. This condition hasn’t been triggered.

Intermediate term OB/OS: This is an intermediate-term overbought/oversold oscillator using the 50 and 150 dma. Triggers of this indicator are indicative of a durable intermediate-term bottom. This hasn’t been triggered.

Bottom durability

So where are we? Three of the components of the Bottom Spotting Model have been triggered. I interpret this as a signal of an imminent bounce, but not a durable intermediate-term bottom. Of my suite of bottom spotting models, NAAIM, the intermediate-term OB/OS, and insider buying. defined as buying (blue line) at or above selling (red line), have been strong indicators of durable bottoms. None of them have been triggered.

My inner trader continues to hold a long position in the S&P 500. A short-term bounce is ahead, but don’t expect much more than that. 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

A golden opportunity

Posted by Cam Hui - March 4, 2025

Gold has caught a bid against a backdrop of trade war fears. On the other hand, gold ETF AUM is skyrocketing, which is contrarian bearish.

Should you jump on the gold momentum train, or fade its rally?

Negative seasonality

The answer depends on your time horizon. Callum Thomas pointed out that March tends to a period of negative seasonality for gold prices. Buyers should therefore be cautious.

A long-term breakout

However, investors should nevertheless consider that gold is on the verge of an upside relative breakout against the S&P 500. It has already broken out against the passive Vanguard 60/40 fund (VBINX). These are highly constructive signals for gold from a long-term perspective.

Inflation ahead

In addition, ISM prices paid has shown a 6-9 month leading relationship with inflation, which should be bullish for gold prices in the near future.

This is consistent with the observation of an upward sloping trend in inflation surprise on a global basis.

From a trader’s perspective, I would be inclined to monitor the 14-day RSI of Gold Miners (GDX) for clues of a tactical bottom. If history is any guide, an oversold condition in the 14-day RSI (top panel) is a sign that the bottom is either near or at hand.

What should you buy as the Magnificent Seven falters?

Posted by Cam Hui - March 2, 2025

Preface: Explaining our market timing models

The latest signals of each model are as follows:

Ultimate market timing model: Buy equities (Last changed from “sell” on 28-Jul-2023)
Trend Model signal: Neutral (Last changed from “bullish” on 15-Nov-2024)
Trading model: Bullish (Last changed from “neutral” on 28-Feb-2025)

Subscribers can access the latest signal in real time here.

The end of American Exceptionalism?

U.S. equities have been on a tear relative to non-U.S. markets since the GFC. Now that the S&P 500 has stumbled while Europe and China have taken the lead, I am seeing some calls for the end of American exceptionalism, especially in light of the deteriorating relationship between America and its traditional allies.

The reversal was underscored by widespread concerns over the overvaluation of U.S. equities.

Is it time for investors to pivot into non-U.S. equities?

The Big Picture

Let’s begin by zooming in to a relative performance of different major regions in the past three years. Since the start of 2025, U.S. equities have rolled over in relative performance, while Europe and China have sprinted ahead. Japan and emerging markets ex-China have been market performers.

For another perspective, I use RRG charts to tell the story. Relative Rotation Graphs, or RRG charts, are a way of depicting the changes in leadership in different groups, such as sectors, countries or regions, or market factors. The charts are organized into four quadrants. The typical group rotation pattern occurs in a clockwise fashion. Leading groups (top right) deteriorate to weakening groups (bottom right), which then rotates to lagging groups (bottom left), which changes to improving groups (top left), and finally completes the cycle by improving to leading groups (top right) again.

An analysis of RRG rotation by country shows the U.S. has weakened from the leading quadrant to the weakening quadrant. European markets are in the improving quadrant and about to transition to the leading quadrant. China recovered from weakening to leading, but a number of other Asian markets such as Hong Kong and Taiwan are still in the lagging quadrant, though South Korea is strongly in the improving quadrant. The resource exporting economies of Australia and Canada are still weak and in the lagging quadrant, which is consistent with my previous observation that cyclical industries are not performing well.

Not so magnificent anymore

U.S. relative performance has been hampered by the underperformance of the Magnificent Seven, which had been leading global markets. The accompanying chart shows the Magnificent Seven ETF (MAGS) has lagged the S&P 500 since the beginning of 2025.

The U.S. is also undergoing a growth scare. The Economic Surprise Index, which measures whether economic releases are beating or missing expectations, has fallen into negative territory.

Tactically, signs are appearing that the risk reversal may be nearing an end. The Fear & Greed Index has reached levels when the market has bottomed in the last year.

Other sentiment indicators, such as the AAII sentiment survey, show a spike in bearish sentiment to levels where the stock market has bottomed in the past.

Make Europe Great Again

Across the Atlantic, European equities have been strong, buoyed by the promise of more fiscal stimulus from rearmament efforts. Both the Euro STOXX 50 and FTSE 100 recently reached new recovery highs, though the FTSE 250, which is more reflective of the British economy, is languishing.

I am encouraged by the strength in the European Economic Surprise Index, but warn that EU leadership may be slow to react to the rupture in the transatlantic relationship. The political leadership of the two pillars of the EU, Germany and France, each face their own constraints. Germany’s new chancellor Merz won an election, but he needs to negotiate with a partner to form a government. That process can take months, which leaves Germany rudderless during a critical period. In France, President Macron was weakened by the loss of his parliamentary majority. While French presidents have significant power, Macron nevertheless has to contend with a majority of left-wing parties who impede his agenda.

Despite the investor stampede into European defense, my preferred sector in Europe is financial stocks, which has shown a strong relative uptrend that began last August, though they are a little extended on a short-term basis.

An unconvincing rally

Over in Asia, the strength in Chinese stocks looks unconvincing. The rally was led by Chinese technology and internet stocks, which failed at a key resistance level. Conventional indicators of Chinese economy strength, such as the cyclically sensitive base metals/gold and copper/gold ratios, have gone nowhere. China has been a voracious consumer of global commodities and the lack of cyclical strength in commodity prices represents a negative divergence.

Here is another perspective on China and its effects on the global cycle. Even though the CRB Index has rallied, the relative performance of major resource exporting countries is not showing any signs of strength. This represents a cautionary flag about both the sustainability of a Chinese economic recovery and the cyclical outlook of global economic growth.

Key risk

In summary, global equity markets are undergoing a rotation away from U.S. into non-U.S. markets. However, investors should heed the following warning from Bloomberg U.S. chief economist Anna Wong. The current narrative of U.S. weakness is likely to shift to non-U.S. weakness as the Trump tariffs begin to take effect later this year. Particularly vulnerable are current account surplus countries like China, Germany and Ireland, though the latter is attributable to tax avoidance by U.S. companies with Irish subsidiaries. Other vulnerable trade war targets include the former NAFTA trading partners Canada and Mexico.

The week ahead

Looking to the week ahead, the bulls will be relieved that the worst of February negative seasonality is behind us and seasonal patterns call for a relief rally in early March.

This is consistent with the observation that the price momentum unwind of the high-octane and high beta stocks is done. The relative performance of momentum ETFs are all seeing minor reversals.

Two components of my Bottom Spotting Model triggered buy signals late last week. The VIX Index spiked above its upper Bollinger Band, indicating an oversold market, and the term structure of the VIX briefly inverted, indicating fear.

In conclusion, a global rotation analysis reveals a rotation away from U.S. equities. Europe is poised to sustain leadership, and my favourite sector is European financials. China has shown signs of relative strength, which doesn’t appear to be sustainable. The most vulnerable countries appear to be the resource exporters such as Australia, Canada, Brazil, Indonesia and South Africa.

Subscribers received an alert Friday morning that the trading model had taken a tactical long position in the S&P 500. My inner trader bought into the market hoping for a short-term scalp. I don’t expect to be in that trade for more than a week. 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

Bessent gets his wish, but not in a good way

Posted by Cam Hui - March 1, 2025

Treasury Secretary Scott Bessent recently declared that the Trump Administration was mainly focused on lower the 10-year Treasury yield. He seems to be accomplishing his goals. Yields are moderating, and the MOVE Index, which measures bond market volatility, is relatively tame. He is achieving his objective, but at a price – by tanking the economy.

Fragile and unbalanced growth

A recent WSJ article revealed that the top 10% of Americans account for about half of all consumer spending. The cumulative excess savings of this group rose and remained steady in the wake of massive fiscal and monetary COVID-era stimulus. By contrast, excess saves of the other 90% have declined.

In other words, the U.S. economy now depends on the high-end consumer, which makes for highly fragile and unbalanced growth. Here’s a case in point. Walmart, whose sales are more exposed to the lower income consumer, described the consumer as resilient during its earnings call, but with the caveat that “we’re seeing higher engagement across income cohorts, with upper-income households continuing to account for the majority of share gains”.

Such an uneven distribution makes growth increasingly reliant on further gains in the wealth effect in the form of rising equity and property prices. Since the top 10% owns most of the wealth in the U.S., this makes the economy highly vulnerable to shocks in asset prices from a negative wealth effect.

Here are the risks. I have already extensively documented how the valuation of the S&P 500 is stretched by historical standards. Here is a compilation of valuation metrics from Mark Hulbert showing the S&P 500 is wildly overvalued by historical standards.

In the face of elevated valuation, some worrisome developments are appearing. While the House budget blueprint passed last week may be regarded as constructive inasmuch as it proposes to extend the TCJA tax cuts, the tax cut extensions represent the status quo and they are not fiscally stimulative. On the other hand, the extension was accompanied by significant cuts of $1.5–$2 trillion to the budget, which is a form of fiscal contraction and therefore equity bearish. The cuts are the equivalent of a tax increase to the lower income cohorts, which will restrain growth. To be sure, the budget blueprint will take time to become law as the legislation winds its way through the Senate, followed by a reconciliation process. Nevertheless, the fiscal plan, as presented, represents an unwelcome fiscal contraction that is equity negative.

Notwithstanding the budget developments, there is already growing evidence of a deceleration in the growth outlook. The Economic Surprise Index, which measures whether economic releases are beating or missing expectations, has fallen into negative territory.

The jobs market is also softening. The continuing message from successive JOLTS reports tells the story that it’s increasingly difficult to find a job. Leading indicators of employment, such as temporary jobs (blue line) and the quits/layoffs ratio (red line), are declining.

The above data does not include the DOGE layoffs, which will become evident in the March Payroll Report. Estimates of federal government employment show that there are 2–3 government contractors to every government employee, so the scale of the job loss may be worse. In addition, state and local government employment has been contracting.

Bloomberg Economics modeled the effects of DOGE cuts under differing scenarios and projects the peak effects would be seen in H1/26. All else being equal, GDP growth slows, unemployment rises, inflation falls and the Fed cuts more than what the market is currently expecting.

Mission accomplished, as measured by the 10-year Treasury yield, but falling growth will be bearish for stock prices.

Uncertainty = Weak capex and hiring

Business uncertainty is also rising. The Dallas Fed Survey of businesses provided a fascinating window into growing concerns over tariffs and other Trump policies, which will hinder capital expenditure and hiring plans. Here are some selected responses:

Chemical Manufacturing: “Tariff threats and uncertainty are extremely disruptive.”
Food Manufacturing: “The current political environment under President Trump has increased the uncertainty of the consumer market. As a food manufacturer, we have noticed small customers are struggling (unable to pay bills on time), and the larger national customers have reduced their purchases. Imposing tariffs on our major trading partners will lead to higher consumer prices…Immigration laws and raids [are affecting our business].”
Miscellaneous Manufacturing: “The uncertainty in tariff threats and general chaos of another Trump presidency is weighing heavy on our business. All customers are decreasing or pushing out orders—taking a wait-and-see posture.”
Non-metallic Mineral Product Manufacturing: “It is very hard to plan. Interest rates? Tariffs? Wow.”
Printing and Related Support Activities: “I’m very worried about the possible tariffs affecting some of our material costs, which we will have no choice but to pass along to our customers.”
Transportation Equipment Manufacturing: “The new tariffs will have a big impact on the demand for our products. This applies primarily to the 25 percent on goods from Mexico. The impact of the additional 25 percent for steel and aluminum will also be detrimental to demand, the extent of which is still being evaluated.”

Unrelated to the business survey, the Dallas Fed Manufacturing Index also came in below expectations: new orders; production; shipments; and employment were all weak.

Weakening housing

In addition, the housing sector, which represents the other leg of asset wealth and a highly cyclical part of the economy, is flagging. While my base case does not call for a recession, rollovers in housing starts have been reliable recession indicators.

This is occurring against a backdrop of worsening housing affordability, which is higher than what was seen at the peak of the last housing bubble.

Homebuilder sentiment has cratered, and the relative performance of homebuilding stocks is rolling over against a backdrop of rising pressure from higher lumber prices owing to tariffs from Canadian imports. Anecdotally, Home Depot’s earnings report tells the story of missed expectations. The company cited “ongoing pressure on large remodeling projects” and “uncertain macroeconomic conditions and a higher interest rate environment that impacted home improvement demand”.

Not the Apocalypse

Despite all of the dire news, I am not projecting a recession, just a growth scare and reset of growth expectations.

Junk bond yields, which is a real-time proxy of the equity risk premium, are showing few signs of stress that’s seen during recessions.

As long as inflationary expectations remain well anchored and bond yields stay low, I expect that stock prices will undergo a corrective price reset of growth expectations but not a recessionary bear market.

Investors should nevertheless be mindful of my recent warning of a long-term market top based on the negative 14-month RSI divergence. The macro backdrop is suggestive of a brief but sharp price drop, not a prolonged recession-induced bear market.

In conclusion, the U.S. economy is increasingly dependent on the well-being of the high-end consumer, whose wealth is reliant on continuing increases in stock and property prices. But cracks are appearing in both markets. Economic growth is slowing, employment is cooling and housing is weak. I expect a reset in growth expectations will lead to a short and sharp correction, but no prolonged recession-induced bear market.

Trading is hard, my head hurts

Posted by Cam Hui - February 26, 2025

Mid-week market update: Is the correction over? The S&P 500 was down -3% on a peak-to-trough basis. The 5-day RSI is severely oversold, which has signaled relief rallies in the past (blue circles). On the other hand, the percentage of stocks above their 20 dma is not oversold, which have been more definitive signals of durable bottoms (pink vertical lines). As well the NYSE net highs-lows is showing both a series of higher lows and lower highs.

Trading is hard. My head hurts.

Here are the bull and bear cases to consider.

The bull case

Let’s start with the bull case, the Fear & Greed Index has fallen to levels consistent with tactical bottoms in the past year.

Jim Paulsen observed that Trump has dramatically increased economic uncertainty, which is contrarian bullish.

In the past, such episodes have tended to resolve bullishly.

In addition, Steve Suttmeier at BoA pointed out that year 1 seasonality calls for a weak February and a rebound in March. The market’s seasonal headwinds should start to diminish next week.

The case for a deeper correction

Here is the case for a deeper correction. Goldman Sachs pointed out that retail investors have been piling into the stock market recently, with the flows concentrated in the technology names.

Goldman strategists have called for traders to fade the retail stampede. Indeed, the latest market downdraft appears to be a price momentum unwind, which may not be complete just yet.

In addition, Commodity Trading Advisors (CTAs) are projected to be selling equities under every scenario over the coming weeks and month.

The NVIDIA wildcard

Investors and traders will also have to contend with the NVIDIA earnings report, which is scheduled for after the market close today. I have no idea of what their results will be, but a TD Cowen research report surfaced on the weekend which reported that Microsoft had canceled contracts for data centre leases. This is a potentially ominous development for the expected growth rate of the hyperscalers and could be the first crack in the AI bullish thesis.

Tail-risks

As well, the tail-risks that I identified on the weekend remain in play. Bitcoin, which is a real-time proxy for banking system liquidity, has violated a key support level. The relative performance of ARK Investment (ARKK), which represents speculative growth stocks, has broken down too.

The USDJPY exchange rate is hovering just below the psychologically important support level of 150. The combination of rising JGB yields and falling UST yields have the potential to set off another Yen carry trade unwind risk-off stampede.

The verdict

What the verdict? The market is short-term oversold and due for a bounce. I would prefer to wait and see how it behaves after the initial relief rally before rendering a bull or bear decision.

For what it’s worth, only one of the components of my bottom spotting model flashed a buy signal during the latest downdraft. The VIX Index spiked above its Bollinger Band, which is an oversold signal. The term structure of the VIX neared an inversion, indicating fear, but never reached those levels on a closing basis.

My personal inclination is to call any bounce a dead-cat bounce and postulate a deeper correction, but it’s not a high conviction call. My inner trader is remaining on the sidelines and unwilling to take a position ahead of what is essentially a coin flip on NVIDIA. In addition, Trump outbursts like the one today about slapping a 25% tariff on the EU is a reminder that sudden bursts of volatility are always lurking below the surface.

White smoke from the market’s conclave?

Posted by Cam Hui - February 23, 2025

Preface: Explaining our market timing models

The latest signals of each model are as follows:

Ultimate market timing model: Buy equities (Last changed from “sell” on 28-Jul-2023)
Trend Model signal: Neutral (Last changed from “bullish” on 15-Nov-2024)
Trading model: Neutral (Last changed from “bullish” on 17-Jan-2025)

Subscribers can access the latest signal in real time here.

The market’s conclave

The recently released film entitled “Conclave” tells the story of how Vatican cardinals sought to elect a new pope after the death of the old one. The film is focused on the conclave, or the meeting of cardinals, as they are locked up in the Vatican and the political maneuvers of the different factions in electing their candidate. The situation is fluid and emerging leadership is highly uncertain.

That’s where the stock market is today. The large-cap growth old leadership is faltering, and different candidates are vying for the top spot. I use RRG charts to tell the story. Relative Rotation Graphs, or RRG charts, are a way of depicting the changes in leadership in different groups, such as sectors, countries or regions, or market factors. The charts are organized into four quadrants. The typical group rotation pattern occurs in a clockwise fashion. Leading groups (top right) deteriorate to weakening groups (bottom right), which then rotates to lagging groups (bottom left), which changes to improving groups (top left), and finally completes the cycle by improving to leading groups (top right) again.

An analysis of RRG rotation shows that growth sectors, technology, communication services and consumer discretionary, which is dominated by Magnificent Seven giants Amazon and Tesla, are weakening. While technology and communication services remain in the top right leading quadrant, they are likely to fall into the bottom right weakening quadrant in the near future if they follow the normal clockwise rotation pattern.

The contenders for the new leadership are value stocks, consisting of financials, industrials, energy and materials, and defensive stocks, consisting of healthcare, consumer staples, utilities and real estate. A growth to value rotation would mean a bullish and benign internal rotation for stock prices, while the emergence of defensive sectors as market leaders is a signal of a market pullback.

In the meantime, the market is waiting for the white smoke from the market’s conclave that signals which faction won in the end.

A sector leadership review

I review the relative returns of the different sectors for some clues.

A review of the relative performance of the growth sectors shows that only communication services has shown consistent positive relative strength. The relative performance of the other two sectors can only be best described as choppy.

The NASDAQ 100, which is a proxy for growth stocks, is also exhibiting some worrisome market internals. Even as the NASDAQ 100 broke out to all-time highs, the relative returns of the Magnificent Seven (bottom panel, red line) has falter0ed. This is another sign of weakening large-cap growth leadership.

The relative performance of the cyclically sensitive value sectors does not inspire high confidence in their leadership qualities. Financial stocks have seen a bid, but that’s probably attributable to the anticipation of further deregulation which benefits banking profitability. The relative returns of the other value sectors are choppy, though material stocks may be trying to form a relative bottom.

The relative performance of defensive sectors are all showing signs of bottoming patterns, but they have not exhibited definitive signs of leadership qualities that indicate the bears have taken control of the tape.

Liquidity headwinds

What could tip the market into a pullback instead of a rolling correction? One headwind that it faces is diminishing banking system liquidity.

Stock prices have been correlated with liquidity, but liquidity has been going sideways for several months while the S&P 500 has advanced.

Bitcoin has been regarded as a real-time proxy for liquidity, which has shown a strong correlation with the S&P 500. Bitcoin has begun to diverge negatively against the stock market in the past few weeks.

The previous chart was based on weekly prices, here is a daily price close-up, which shows that Bitcoin has been flat to down while the S&P 500 staged a marginal breakout to all-time highs. In addition, MarketWatch reported that the on-chain demand for Bitcoin has been weak: “Bitcoin’s apparent demand — or the difference between the amount of bitcoin mined and the inactive supply for over a year — fell from a high of 279,000 in December to around 62,500 as of Wednesday [February 19th}.” Downward pressure on Bitcoin prices has the potential to translate into weakness in the S&P 500.

Watch the Yen

Another tail-risk to consider is the potential of a repeat of the yen carry trade unwind, which sparked a sudden risk-off episode last August. Yields on JGBs have recently surged as the Bank of Japan’s monetary policy has turned more hawkish, which puts upward pressure on the yen. Further yen strength that moves the USDJPY rate decisively below the 150 level could spark another risk-off episode.

Japan’s January core CPI came in ahead of expectations, and along with continual strength in the Economic Surprise Index has the potential to put upward pressure on Japanese rates and the yen exchange rate.

The week ahead

Where does that leave us? The S&P 500 staged marginal upside breakouts to a marginal all-time high last week, led by the NASDAQ 100. Both indices weakened below support-turned-resistance and tested their respective 50 dma. The equal-weighed S&P 500 never staged an upside breakout, and the mid-cap S&P 400 and small-cap Russell 2000 are languishing below their 50 dma.

From a technical perspective Further S&P 500 weakness could target the price gap that begins just below 5900. Keep in mind, however, the S&P 500 closed Friday at roughly the level seen on Trump’s Inauguration Day. It remains to be seen whether the Trump Put would activate should stock prices weaken further.

Major sources of volatility in the coming week will be the NVIDIA earnings report and a decision on the delayed 25% tariffs on Canada and Mexico should be forthcoming. Mr. Market seems to be shrugging off the tariff threat by focusing on Trump’s pro-growth policies and believe that tariffs are only a bluff. This is not the kind of environment to be taking on more risk.

In conclusion, a sector rotation analysis reveals a market lacking in leadership, divided between a scenario of a rolling rotation from growth to value or a corrective pullback. My base case calls for a minor correction. The market faces several cross-asset headwinds from weakening banking system liquidity, a threat of a replay of the Yen carry trade unwind and renewed threats to growth from a trade war.

Could a cyclical rebound give the bulls a second wind?

Posted by Cam Hui - February 22, 2025

Callum Thomas of Topdown Charts recently argued for the emergence of a global cyclical rebound based on a synchronized central bank easing. Such a scenario of rising inflationary pressures is a signal of a renewal of cyclical rebound in demand.

I have some sympathy to that view. I have been bullish on gold for some time, and gold is the classic hedge against unexpected inflation. On the other hand, it runs contrary to my observation that the S&P 500 is undergoing a topping formation (see A Long-Term Sell Signal?).

What’s the real story?

What cyclical rebound?

Tactically, I can see few signs of a cyclical rebound in the U.S. The Citi Economic Surprise Index, which measures whether economic releases are beating or missing expectations, has been weak.

The relative performance of major cyclical industries doesn’t exactly scream “cyclical reflationary rebound” either. All industries are flat to weak.

Can China lead the way?

Where will the rebound in growth come from?

A clue can be found in the latest BoA Global Fund Manager Survey, which reported that respondents were all bulled up as cash levels are at a 15-year low. Global institutions believe the most bullish development is an acceleration in Chinese growth.

Indeed, the market has become excited over Xi Jinping’s embrace of Chinese business moguls, including the formerly ostracized Alibaba founder Jack Ma. The initiative has lit a fire under Chinese internet stocks. The Chinese Internet ETF (KWEB) surged to test a key resistance level. An upside breakout opens up enormous upside potential as it would represent a breakout from a multi-year base.

Could China be the source a global cyclical rebound?

I am skeptical for two reasons: KWEB appears overly extended in the short-term; and a definitive upside breakout seems unlikely. As well, a review of the relative performance of China and other Asian stock markets shows that regional markets are not confirming the China revival theme. I interpret this as a sign to fade the enthusiasm over the prospect of a China-led reflationary rebound.

The trade war threat

By contrast, the greatest potential headwind to growth is a potential trade war. To be sure, trade patterns have significantly changed in the last quarter-century. The U.S. was the dominant global trade partner in 2000, but China now occupies that position. President Trump has chosen to respond with the imposition of tariffs to reshore manufacturing to the U.S.

According to Robin Brooks, China’s trade surplus excluding commodities has been steadily growing and the biggest culprit is the chronic undervaluation of the Chinese yuan. This analysis led Bloomberg Chief U.S. Economist Anna Wong to conclude that her baseline is a U.S. tariff rate of 45% on Chinese imports, which is not in anyone’s spreadsheet models.

The tariff threat creates uncertainty for corporate executives, which will delay plans for capital expenditures and new hiring. Mentions of “tariffs” in earnings calls have exploded upwards.

The tariff list is growing almost every day. Trump has imposed an across-the-board tariff rate of 25% on Canada and Mexico, 10% on China, 25% additional tariffs on aluminum and steel imports, and reciprocal tariffs on other countries. He also threatened a tariff of about 25% on autos, semiconductors and pharmaceuticals which will go into effect on April 2. Many of these initiatives have the potential to cripple U.S. economic growth but the market has shrugged off the potential effects. The Budget Lab estimates that just the implementation of the announced reciprocal tariffs would raise the effective tariff rate to 13%, a level not seen since 1937.

While company analysts haven’t revised their earnings estimates because the actual details of the tariffs aren’t known, Street economists and strategists have scrambled to quantify their effects. As examples, Goldman Sachs chief economist Jan Hatzius found that capital expenditure plans will fall -1% on quarter-over-quarter basis for companies with high sales exposures to Canada, Mexico and China. BoA quantitative strategist Savita Subramanian projects that S&P 500 earnings could fall by as much as -8%.

The release of the January FOMC minutes revealed some concerns about the inflationary effects of potential tariffs. The Fed’s base case called for inflation to slow gradually: “Participants expected that, under appropriate monetary policy, inflation would continue to move toward 2 percent, although progress could remain uneven”, but “other factors were cited as having the potential to hinder the disinflation process, including the effects of potential changes in trade…policy”. In contrast to Trump’s first trade war when businesses showed a greater propensity to absorb some of the tariff increases: “Business contacts in a number of Districts had indicated that firms would attempt to pass on to consumers higher input costs arising from potential tariffs”, which raises the odds that the Fed would stay on hold for longer in its rate cutting cycle.

The market doesn’t seem to be discounting these aforementioned risks, which is consistent with the Wall Street adage that the stock market takes the stairs up and the elevator down. I believe the odds of rising tariffs and a trade war are higher than what the market is pricing. Trump’s desire to address trade imbalances has long been a bedrock initiative of his political campaign. In addition, the Trump Administration regards tariffs as a useful revenue source to offset the cost of the TCJA tax cut extension, which is another important legislative priority.

In conclusion, the backdrop of synchronized monetary easing by central banks around the world should lead to a global cyclical rebound under normal circumstances. However, market internals in the U.S. and Asia are not supportive of the cyclical rebound scenario. The market isn’t discounting the very real threat of a trade war, which threatens to derail the current cyclical equity bull.

Who’s left to buy?

Posted by Cam Hui - February 19, 2025

Mid-week market update: The results of the latest sentiment surveys argue that this is a time for caution. The BoA Global Fund Manager Survey shows cash at a 15-year low.

The institutions are all-in on risk. Who’s left to buy?

A Charles Schwab survey of client accounts show that cash levels are near historical lows. If institutions and retail are all-in, who’s left to buy?

Jurrien Timmer at Fidelity issued a similar warning:

Following election day, [price] discovery went vertical, but by now the pro-growth story has been priced in, while some of the potential negatives are being ignored (the CPI report and tariffs being two examples). As a result, sentiment is bullish, credit spreads are narrow, the equity risk premium (ERP) is in the 10th decile, and the VIX is at 15. The market appears to be priced for success.

This will not end well

Keep in mind that these are only “this will not end well” warnings, which are condition indicators and not trading indicators. Over in the bond market, junk bond yields are low, but show no signs of stress. While this may be an accident waiting to happen, we have no idea of what the accident might be.

The BoA Global Fund Manager Survey shows that risk appetite is elevated, but readings are not wildly overbought. Stock prices could go higher from here.

A reversal?

With positioning so bullish, the greatest risk to the market occurs when sentiment starts to reverse from an extreme, which is the pattern traced out by Callum Thomas’ Euphoriameter.

In the short run, my anticipated price reversal hasn’t happened yet. The S&P 500 made another marginal new all-time high today, but breadth participation continues to be weak. At a minimum, I am not inclined to chase this rally.

Will the real stock market please stand up

Posted by Cam Hui - February 16, 2025

Preface: Explaining our market timing models

The latest signals of each model are as follows:

Ultimate market timing model: Buy equities (Last changed from “sell” on 28-Jul-2023)
Trend Model signal: Neutral (Last changed from “bullish” on 15-Nov-2024)
Trading model: Neutral (Last changed from “bullish” on 17-Jan-2025)

Subscribers can access the latest signal in real time here.

Which index should you believe?

It is said that there is nothing is more bullish than higher prices, but this time may be different. Even as the S&P 500 staged an upside breakout from a wedge formation and it’s on the verge of testing overhead resistance, the equal-weighed S&P 500, which gives higher weight to the smaller stocks in the index, is barely holding at the 50 dma. The mid-cap S&P 400 and the small-cap Russell 2000 are trading below their respective 50 dma.

Which index should you believe? These manifestations of weak breadth makes me nervous that the latest rally may represent a last hurrah for the bulls.

MarketWatch reported that Goldman Sachs strategies Scott Rubner attributed the price strength to a retail buying stampede, but added, “This is the last bullish email that I will send for Q1 2025 as the flow demand dynamics are quickly changing, and we are approaching negative seasonals.”

In addition to the negative breadth divergence, I am seeing other divergences everywhere.

Negative divergences

Consider the weekly chart of the S&P 500. Even though the index is advancing in a well-defined channel, the 5-week RSI is exhibiting a series of lower highs, which is an indication of weak momentum.

It’s also highly unusual to see the S&P 500 challenging the new highs while the percentage of S&P 500 stocks above their 200 dma fall to 60%. In the past, similar losses of price momentum have been signals of market corrections.

Equity risk appetite indicators are also flashing negative divergences. Both the consumer discretionary to consumer staples ratio and the high beta to low volatility ratio are flashing negative divergences.

The relative performance of defensive sectors are all either bottoming or turning up, which is a warning that the bears may be about to take control of the tape.

Q4 earnings season is mostly over. Both the EPS and sales beat rates are below average. Forward EPS revisions are stalling. Revisions were flat over one week and negative over two weeks, which is indicative of weak fundamental momentum.

Another worrisome development is the violation of the S&P 500 December lows in early January. Ryan Detrick of Carson Investment Research found that market returns have been subpar in such instance, though they don’t signal outright bear markets.

Waiting for the bearish catalyst

Putting it all together, the technical structure of the stock market points to an impending correction. I just don’t know the nature of the bearish catalyst. The most likely culprit is a negative reaction to Trump trade war news.

On one hand, the USD weakened in February, indicating that the market believes that Trump is either bluffing on his tariff threats or using tariffs as a negotiation tool as the latest announcements contained no specific timetable for implementation. On the other hand, Trump factors show that companies with domestic revenues are outperforming, indicating tariff anxiety, as well as rising inflation expectations from tariff implementation. In addition, the Washington Examiner reported that the Trump Administration is penciling up to $1 trillion in additional revenues from reciprocal tariffs, which amounts to a gargantuan sales tax increase as 2024 goods imports was $3.3 trillion.

In conclusion, even as the S&P 500 tests overhead resistance at its all-time high, I am seeing negative divergences everywhere. I interpret this as a market poised for a corrective pullback. The most likely bearish catalyst is a negative reaction to a Trump trade war announcement. Market internals show that investors are discounting both rising trade war tensions and inflation expectations.

What the surge in gold tells us about the stock market

Posted by Cam Hui - February 15, 2025

Even though it’s still early in the year, my bullish call on gold has worked out well (see 2025 High Conviction Idea: Gold). Gold has reached an all-time high in all currencies. In particular, it broke out to a new high in the Swiss Franc (CHF), which is regarded as a hard currency, and the Chinese Yuan (CNY), which is reflective of Chinese demand.

Beyond the bullish outlook on the yellow metal, here are the asset return implications.

Gold’s bullish drivers

First, let’s consider the long-term upside potential for gold for the current market cycle. With gold approaching the $3,000 level, a 5% box and 3-box reversal point and figure chart shows an upside objective of $5,603.

The strength in gold hasn’t being driven by its conventional drivers, USD weakness and the use of the metal as a hedge against inflation. The USD has been strong, and the price of TIPs is well below its highs achieved in late 2021.

Instead, the latest gold bull has mainly been driven by emerging market demand. In the wake of the U.S. weaponization of SWIFT after the onset of the Russo-Ukraine War, EM central bank demand has spiked as China and other central banks move to de-dollarize their reserves. In addition, China has allowed insurers to invest in gold, which is another source of potential demand.

Callum Thomas of Topdown Charts has observed a longer trend of renewal in central bank demand.

A regime shift

The latest surge in gold has left the metal outperforming the S&P 500. Bloomberg columnist John Authers speculated that this may be a bearish warning for stocks. While this study represents a sample size of one, Auther’s thesis is consistent with my observation that the S&P 500 may be undergoing a cyclical top in H1 2025 (see A Long-Term Sell Signal?).

Notwithstanding the bearish implications for stock prices from gold, I think that the upside breakout at $2,100 was the signal of a regime shift in return patterns. Here are my takeaways from the accompanying chart of factor returns:

The Gold/S&P 500 ratio is making a multi-year saucer bottom. The last time this happened0 gold staged a similar cup and handle upside breakout that resolved in a strongly bullish fashion.
While the Gold/S&P 500 ratio hasn’t staged an upside breakout, the Gold/60-40 ratio is on the verge of a breakout. I interpret this to mean that gold has a role in balanced fund portfolios in the coming cycle as it acts as a counterweight against bond market weakness.
I am also seeing similar long-term bottoming patterns in U.S. equity factor returns. The small-cap/large-cap ratio and value/growth ratios are all starting to bottom and turn up. Cha0nges in leadership usually occur during a bear market. The old leaders, such as th0e Magnificent Seven, lag the market and new leadership emerges out of the ashes of the bear market as the next bull is reborn.

An opportunity in gold miners

For investors who cannot hold gold or gold bullion by mandate, gold mining stocks may represent a useful way to gain exposure to the gold bull. Callum Thomas has argued that the valuation of these stocks is not overly demanding, both on a relative and absolute basis.

Sentiment in gold miners appears washed out, which makes these stocks a rare combination of contrarian opportunity and positive price momentum.

Tactically, gold mining stocks appear overly extended in the short run. The 14-day RSI recently reached 75 and pulled back, which is consistent with short-term tops in the past. As well, the gold miner/gold ratio reached the top of its Bollinger Band, which is another overbought signal. However, the percentage bullish indicator (bottom panel) is not extreme, which I interpret as a likely renewed bull in gold mining stocks after a brief pullback.

Another factor supporting the rise in gold prices may be a shortage of physical gold in London, which manifested itself in a spike in gold lease rates. That’s because the gold quote in New York includes any tariffs. In anticipation of the imposition of tariffs, dealers moved their physical gold inventory from London to New York, which created a physical shortage in London. I believe this fear is short term in nature and should resolve itself in the near future. There is no shortage of physical gold. Fade the panic.

In conclusion, a review of gold’s price action leads me to the following conclusions:

The gold bull is just starting, with strong upside potential in the coming investment cycle.
The market is undergoing a regime shift. Gold will be a useful asset to hedge against bond market weakness in the coming cycle, which will see small caps dominate large caps and value dominate growth.
Gold mining stocks present a long-term opportunity, but may be vulnerable to a short-term setback.

Ignore rising tail-risk at your own peril

Posted by Cam Hui - February 12, 2025

Mid-week market update: The latest update of Bloomberg Intelligence Market Pulse Index shows that it’s at manic levels.

The market seems to be ignoring tail-risk, which is an increasingly worrisome development.

Inflation risk

Stock prices have held up remarkably well in the face of worries about DeepSeek, Trump tariffs, geopolitics, and other economic developments. Take today’s hot CPI report, as an example. Core CPI came in higher than expected, which dampened any expectations of a rate cut in the near future.

Moreover, the University of Michigan inflation expectations report had a glass half-full and half-empty quality. Inflation expectations rose overall, but expectations were highly bifurcated depending on the political views of the respondent. Republicans expect zero, or near-zero, inflation, but Democrats expect inflation to surge. The glass half-full interpretation is this sentiment survey has become useless as it just reflect political partisanship. The more ominous glass half-empty interpretation is inflation expectations are becoming unanchored to the downside for Republicans and to the upside for Democrats, which is an unwelcome development for Federal Reserve policy makers.

Sleepwalking into a trade war

The market also seems to be ignoring the risks of a trade war. When Trump announced a 25% tariff on Canada and Mexico, and 10% tariff on China, stock prices fell, but recovered when Trump walked back and delayed the tariffs on Canada and Mexico for a month. It barely budged when he announced additional tariffs on aluminum and steel imports, and reciprocal tariffs on unspecified countries. This was in the face of Ford CEO warning of the aluminum and steel tariffs causing chaos in the auto industry (see CNBC report).

George Pearkes argues that the market is really bad at pricing binary outcomes, such as the prospect of tariff-induced trade war, until it happens. He cited the example of the COVID Crash: “We had cases in the US in January, the first public death Jan 9, the genome was sequenced Jan 10, and markets kept rising until February 19.”

Similarly, the stock market didn’t react to trade war in 2017-2018 until it stared the news in the face.

Other risks

The market seems to ignoring other key risks. The House and Senate can’t seem to agree on a budget. Even if Congress were to agree on a bill that extends the TCJA tax cuts, which is an important Trump legislative priority, its passage doesn’t inject additional economic stimulus because it represents the status quo. Not known are the extent of spending cuts to pay for the tax cuts, which represents fiscal contraction that poses a headwind to stock prices.

As well, Trump threatened that “all hell would break loose” if Hamas doesn’t release all of its hostages by Saturday. His belligerent remarks puts the Netanyahu-led Israeli government in a difficult position, as it can’t be seen to be hawkish than Trump. Conceivably, the tail-risk of an attack on Iran could grow if the Saturday deadline is passed without a satisfactory resolution.

We are approaching a seasonally positive period for the VIX Index, which raises the odds of a volatility spike in the near future.

In the meantime, the SKEW Index, which measures the price of hedging downside tail-risk, is at elevated levels since the election but readings aren’t extreme.

Be prepared.

Still no change: Just a sell signal set-up

Posted by Cam Hui - February 9, 2025

Preface: Explaining our market timing models

The latest signals of each model are as follows:

Ultimate market timing model: Buy equities (Last changed from “sell” on 28-Jul-2023)
Trend Model signal: Neutral (Last changed from “bullish” on 15-Nov-2024)
Trading model: Neutral (Last changed from “bullish” on 17-Jan-2025)

Subscribers can access the latest signal in real time here.

Good news, bad news

I have some good news and bad news for you.

The bad news is the long-term sell signal from one of my timing models, which is calling for a major top in the S&P 500. This model buys when the MACD of the NYSE Composite (bottom panel) turns positive and sells when the 14-month RSI (top panel) shows a negative divergence, which just happened at the end of January. The good news is the actual market top may take several months after the signal to achieve, and I don’t have actionable tactical sell signals just yet.

The tactical news is the short-term technical picture hasn’t changed very much in in the last few weeks. The market is still choppy and range-bound.

Bearish confirmations

I am seeing other confirmations of long-term weakness. I have highlighted the negative breadth divergence from different Advance-Decline Lines, which failed to make an all-time high even as the S&P 500 did so in January.

Technical analyst Willie Delwiche confirmed the negative breadth divergence globally by pointing out the contraction of global markets making new highs.

Other indicators are flashing warning signs. The BoA’s Sell Side Indicator, which measures Wall Street strategist sentiment, is within a hair of a sell signal. Street sentiment is becoming a little giddy, which is contrarian bearish.

SentimenTrader also observed that the S&P 500 Sharpe Ratio, which is an indicator of risk-adjusted returns, recently approached 2.0 and retreated. While the sample size is small (n=2), past instances were “too good to be true” episodes that resolved in bear markets.

Michael Howell of CrossBorder Capital, who is the guru of global liquidity, is calling for the top of a 5–6-year liquidity cycle in mid-2025 in an interview. This is consistent with my view of a major market top in H1 2025.

The latest quarterly Senior Loan Officer Opinion Survey (SLOOS) conducted by the Fed was somewhat troubling. Small firms are increasing loan demand, but banks are tightening credit, which is not conducive to growth. I focus mainly on small firms because they tend to be sensitive barometers of the economic cycle because of their lack of bargaining power — and they are experiencing a credit crunch in slow motion.

That said, all of these warnings fall into the category of condition indicators. They are warning conditions, but don’t work as immediate sell signals. As an example, Howell’s latest (gated) Substack update shows that global liquidity has stabilized due to improved central bank liquidity from the PBOC and ECB, but Fed liquidity remains a problem. Not all is lost yet.

Q4 earnings season has been a bit of a disappointment as the results can be described as neutral to weak. Forward EPS revisions stalled last week, which is indicative of a loss of fundamental momentum. The EPS beat rate was in line with the 5-year historical average, but the sales beat rate was below.

No tactical sell signal

That said, all of these warnings fall into the category of condition indicators. They are warning conditions, but don’t work as immediate sell signals.

The S&P 500 is in a well-defined uptrend, with no signs of a trend break.

From a short-term perspective, the S&P 500 staged an upside breakout from a bull flag (dotted lines) and left an unfilled price gap just below 5900. As long as the index stays above the dotted breakout line, it opens up the possibility of a test of the all-time high. However, the technical structure of the market remains choppy and range-bound.

However, the bulls should be overly excited until they can see an upside breakout to fresh highs and the technical underpinnings of any breakout. Keep in mind that analysis from Almanac Trader shows the second half of February tends to be seasonally negative.

In conclusion, plenty of warnings of a long-term market top are appearing, but the warnings belong to the category of condition indicators and not actionable trading signals. Current conditions amount to just a sell signal setup, and a review of the short-term technical picture shows a resilient market structure. Long-term investment-oriented accounts should de-risk to more neutral positions. Traders can wait for more definitive signs of downside breaks before turning defensive.

Bessent’s challenges in 2025 and beyond

Posted by Cam Hui - February 8, 2025

Treasury Secretary Scott Bessent declared in an interview with Fox Business a surprising target. Bessent and the Trump Administration were mainly focused on lowering the 10-year Treasury yield and Trump is not calling the Fed to lower short-term rates. He also reiterated the Trump Administration’s objective of raising energy output and the extension of the TCJA tax cuts.

Here is the short-term report card. Since the Fed announced its jumbo half-point rate cut in September, the 2-year Treasury yield, which is a proxy of the market’s expectations for the terminal Fed Funds rate, has risen, and so has the 10-year yield. The 2s/10s yield curve steepened, indicating stronger growth expectations.

Since the election, the 2-year yield is roughly flat and the 10-year yield is up marginally. The bond market has shrugged off anxiety over the possible effects of a trade war, when President Trump announced a 25% tariff on Canada and Mexico, which was later walked back, and a 10% tariff on China. More importantly, the U.S. eliminated a de minimis tariff exception on the import of Chinese goods below $800. An entire industry had grown up to exploit this loophole by sending small individual packages to exploit this rule.

So far, so good. The bottom panel of the chart summarizes Scott Bessent’s main challenge in controlling the 10-year yield. The MOVE Index, which is the VIX of the bond market, had fallen since the election and readings are relatively low by historical standards. Bessent’s main task is to calm the bond market and keep anxiety levels low.

Bessent’s tools

Bessent has a number of tools available to him as Treasury Secretary. The first is to signal how he plans to manage the government’s debt. As the Treasury market is the largest and deepest bond market in the world, no government can control it without suffering consequences elsewhere, such as the exchange rate.

The latest Quarter Refund Announcement conveyed a “steady as she goes” message. The expected level of debt issuance is not significantly different than what was a year ago, indicating that Bessent doesn’t expect much progress on the deficit in the near term. In addition, the mix of the issuance of short- and long-term paper was about the same as what it was, despite widespread criticism that the Yellen Treasury was issuing too much short-term paper to boost banking liquidity instead of locking in rates in the longer end of the yield curve.

Bessent’s cautious approach of keeping long-dated Treasury supply relatively low has paid off in the short run, but long-term challenges remain. The non-partisan Congressional Budget Office estimates that fiscal deficits will exceed 5% of GDP for as long as the eye can see — and that assumes the TCJA tax cuts expire. This will put upward pressure on Treasury supply and the 10-year yield as a consequence.

Will supply overwhelm demand under such a scenario? There are some steps the Trump Administration can take to alleviate any potential supply-demand imbalance. Fed Governor Michelle Bowman, who is a front-runner to become the Fed Vice Chair for banking supervision, proposed raising bank leverage ratios in a recent speech:

Where we can take proactive regulatory measures to ensure that primary dealers have adequate balance sheet capacity to intermediate Treasury markets, we should do so. This could include amending the leverage ratio and G-SIB surcharge regulations for the largest U.S. banks. Adopting regulatory changes to mitigate these concerns may not be sufficient to ensure market liquidity, but it would be an important step toward building resiliency in advance of future stress events. In my view, it would be better to fix the roof now, while the sun is shining, by addressing over-calibrated leverage ratio requirements, and considering the unintended consequences of any future capital reforms.

Bowman made a similar suggestion in a speech in January 2024, in the context of addressing possible liquidity problems in the banking system before it occurs:

Looking Beyond Basel III: Leverage Ratio Requirements. Capital requirements are intended to be complementary—risk-based capital rules require banks to hold capital against more granular and specific risks, while leverage requirements operate as a backstop in the ordinary course of business. This arrangement works by design, but we have seen some cracks emerge, particularly around the impact of the 5 percent leverage ratio that applies to U.S. global systemically important banks at the holding company, commonly referred to as the enhanced supplementary leverage ratio (or eSLR). While risk-based and leverage capital requirements are intended to be complementary and promote the safe and sound operation of the banking system, the eSLR can disrupt banks’ ability to engage in Treasury market intermediation, which we saw occur in the early days of market stress during the pandemic. I consider reform of the eSLR to fall in the category of “fixing what is broken.” This is an issue that would be prudent to address before future stresses emerge that could disrupt market functioning.

What does the Fed do?

Even as Bessent focuses on the level of the 10-year yield, which he has no direct control over, he has to contend with the Fed, which controls the short-term rate. Vice Chair Philip Jefferson, who is part of Powell’s inner circle, said in a recent speech that he is in no hurry to cut rates because of the Fed’s data dependence [emphasis added]:

Over the medium term, I continue to see a gradual reduction in the level of monetary policy restraint placed on the economy as we move toward a more neutral stance as the most likely outcome. That said, I do not think we need to be in a hurry to change our stance. In considering additional adjustments to the federal funds rate, I will carefully assess incoming data, the evolving outlook, and the balance of risks

Jefferson’s go slow view was echoed by Dallas Fed President Lorie Logan in a speech last week. She could envisage a scenario in which she wouldn’t support further cuts:

What if inflation comes in close to 2 percent in coming months? While that would be good news, it wouldn’t necessarily allow the FOMC to cut rates soon, in my view.

Suppose, for example, that as the first quarter unfolds, monthly inflation figures come in at a 2 percent annualized rate, labor market indicators hold right where they were all fall, and consumer spending and business investment also stay strong.

I’d find it hard to say monetary policy was meaningfully restrictive in that scenario. One aspect of the global higher-rate environment is that the neutral interest rate appears to have moved up—though it’s uncertain exactly how much. On-target inflation alongside two quarters of stability in the labor market and demand would strongly suggest that we’re already pretty close to the neutral rate, without much near-term room for further cuts. On the other hand, if the labor market or demand cools further, that could be evidence it’s time to ease.

The January Payroll presented a mixed picture. Headline employment came in at 143,000 jobs, which was below the consensus estimate of 169,000, but revisions in November and December added a net 100,000 jobs and the unemployment rate fell from 4.1% to 4.0%. Average hourly earnings spiked in January, but the increase could be related to the cold weather. If sustained, it would represent an unwelcome hawkish development that would put rate cuts on hold. Overall, the report conveyed the picture of a tighter-than-expected labour market.

Trump policy headwinds

Bessent’s desire to maintain a low or stable 10-year yield also faces headwinds from some of Trump’s policies. In addition to the market’s trade war fears, which is a widely shared worry, we have warned in the past about the risks to inflation and economic growth from deportations (see Two Key Risks to the Bull That No One Is Talking About). Both of these issues have drawn increasing concerns on company earnings calls.

Bob Elliott, CEO of Unlimited Funds, highlighted a potential troubling development due to Trump’s strict immigration and deportation policies. Most of the job growth in the latest cycle is attributable to foreign born workers driven by strong immigration, which is about to end.

However, foreigners don’t seem to be pushing out the native-born workers, as the unemployment rates of both groups are very similar.

Not all foreign-born workers are illegal, but if Trump’s deportation policy is sufficiently large in scale, it would remove sufficient people from the workforce to create a worker imbalance and push up wages, which is consistent with Lorie Logan’s scenario of falling inflation and a tight labour market. Moreover, the workforce reduction would put downward pressure on economic growth potential. If labour supply were to stay flat or exhibit weak growth, productivity would have to do most of the heavy lifting if the economy were to grow.

Stagflation would the more likely outcome in such an instance.

Trump’s widespread use of the tariff weapon is also troubling. When he announced a 25% tariff on Canada and Mexico, a WSJ editorial called it “The Dumbest Trade War in History”. Wall Street strategists all marked up inflation forecasts and marked down growth expectations in reaction to the announcement. Trump acknowledged in a social media post that there may be “some pain” as a result of the tariffs.

As it turned out, the tariff threat to Canada and Mexico was defused, though the China tariffs remain in place. China’s retaliation has been relatively light, unlike the last trade war when China targeted America’s farm exports, which had a widespread impact. This is a constructive sign that China is open to negotiations and not ready to engage in a full-scale trade war.

The question for investors is what Trump does next?

The 25% tariffs on Canadian and Mexican goods are only delayed for a month, and he has signaled that he is ready to turn his sights on the EU. The market was rattled Friday when he announced reciprocal tariffs on unspecified countries. He has also shown his willingness to use the tariff threat as a negotiation tool to force concessions in non-trade-related negotiations. Could he deploy such a threat to support his desire to take control of Greenland?

Trump has characterized “tariff” as “a beautiful word”. He has embraced its use as a revenue generation tool as a substitute for income taxes, which is a throwback to the 19th Century. In light of the U.S. Treasury’s budget pressures, excise taxes such as tariffs could be a tempting policy option to raise revenue, which is projected to boost inflation and cut growth.

Scott Bessent, writing as a hedge fund manager, admitted a year ago in a client letter that “Tariffs are inflationary and would strengthen the dollar—hardly a good starting point for a U.S. industrial renaissance.” As well, USD strength is raising the risk of a sudden discontinuous devaluation on countries with Dollar pegs, such as Argentina, Egypt and Turkey, which would raise the risk premium in global financial markets.

The verdict

In summary, Treasury Secretary Scott Bessent’s stated objective of focusing on the 10-year Treasury yield is a sensible one, but he faces a number of key challenges.

The market is giving Bessent the benefit of the doubt for now. The bulls can rightly argue that inflation expectations have declined since the inauguration.

The bears will argue that gold prices, which are a hedge against unexpected inflation, have risen to all-time highs in all currencies.

In the end, much depends on the future trajectory of the term premium, which is the compensation demanded by investors to extend maturity. Any spike in the term premium would pose a serious threat to the success of Trump’s economic agenda, potentially unravel the stability of the Treasury market and crater the appetite for risk assets. Even though the term premium has staged a short and shallow retreat, it remains at a new cycle high and risk levels are elevated.

Waiting for the next market catalyst

Posted by Cam Hui - February 5, 2025

Mid-week market update: What should investors make of the market reaction to the trade war drama? The S&P 500 remains range-bound. The bulls will argue that the index is on the verge of an upside breakout from a bull flag (dotted lines), which is a bullish continuation pattern. The bears will argue that momentum is negative, as evidenced by the recycle of the stochastic from overbought to neutral (top panel) and the percentage of S&P 500 above their 20 dma. One key test of market strength is whether the price gap (shown in grey) at just below 5900 is filled in the near future.

As for me, I am in wait and see mode for the next market catalyst.

Market internals

An analysis of market internals reveal a mild bearish bias. Equity risk appetite factors present a neutral to negative picture. While the ratio of consumer discretionary to consumer staple stocks is tracking the performance of the S&P 500, the relative performance of high-beta to low-volatility stocks is flashing a negative divergence. Negative divergences are also evident in the cyclically sensitive copper/gold and base metals/gold ratios (bottom panel).

The relative performance of defensive sectors shows that they are all trying to bottom, but conditions aren’t definitive enough to assert that the bears have taken control of the tape.

My assessment of the market environment is a choppy trading pattern with a slight bearish bias. Until I see signs of either an upside breakout or downside breakdown, this remains a “buy the dip and sell the rips” market.

Can the stock market vigilantes save the bull?

Posted by Cam Hui - February 2, 2025

Preface: Explaining our market timing models

The latest signals of each model are as follows:

Ultimate market timing model: Buy equities (Last changed from “sell” on 28-Jul-2023)
Trend Model signal: Neutral (Last changed from “bullish” on 15-Nov-2024)
Trading model: Neutral (Last changed from “bullish” on 17-Jan-2025)

Subscribers can access the latest signal in real time here.

A high volatility regime

I told you there would be volatility. In the past week, investors have seen a fright over how advances in artificial intelligence may affect the AI ecosystem, Federal Reserve and European Central Bank interest rate decisions, earnings reports from Magnificent Seven companies such as Apple, Meta, Microsoft and Tesla, and a raft of Trump policy announcements and executive orders that surprised the market.
Global economic policy uncertainty has spiked. Is it any wonder that market volatility follows suit?

Trend? What trend?

As a consequence, it’s a tough time for trend followers because apparent established trends can quickly reverse themselves in this environment.

As an example, the relative returns of price momentum ETFs, which seek exposure to stocks that have gone up the most in the recent past, have gone on roller coaster rides.

Policy implementation fumbles

The Trump White House’s rookie mistakes in policy implementation isn’t helping either. As an example, the Executive Order (EO) on the federal aid freeze had to be reversed, much in the way the travel ban had to be reversed when Trump first took office in 2017. The Trump team drafted the EO without consulting the agencies involved for reasons of secrecy. The result was an order that was badly written, unclear in its objectives, and lacked guidance to agencies in implementation and the specifics of different cases. As a consequence, it had to be withdrawn.

Consider the implementation difficulties of another of Trump’s initiatives, the denial of birthright citizenship to people born in the U.S. to non-citizen parents. Even if it were to survive a constitutional challenge, how does an American born in the U.S. prove citizenship? The conventional method of a birth certificate won’t work anymore. You would need your parents’ birth certificates or naturalization papers, and who has those kinds of records? What if you were born to a single mother and the father is unknown? Even if the government determined that someone is not entitled to citizenship under those provisions, that person could potentially become stateless. Where would you deport someone like that to?

As for the latest announced tariffs of 25% on Canada and Mexico, we believe they were imposed to virtue signal and likely to be reversed in the near future as their costs are too high for all parties involved. It’s unclear what Trump is trying to accomplish with the tariffs on Canada and Mexico. An analysis of trade deficits shows that the lion’s share of the trade deficits are attributable to China and Asia, not Canada and Mexico.

The headline reasoning for the tariffs is the amount of fentanyl crossing U.S. borders. While the amount of fentanyl seized at the Mexican border is considerable, the amount seized at the Canadian border in 2024 was only 43 pounds.

A recent Bank of Canada study which modeled the effects of a 25% tariff on Canada projected a -6% growth effect on GDP, which amounts to a deep recession. Trade within the USMCA bloc in 2020 accounts for 29% of Canadian GDP, 40% of Mexican GDP and 10% of U.S. GDP. Undoubtedly the effects of a 25% tariff on Mexican goods would be the same order of magnitude or worse. Slowdowns of that magnitude in Canada and Mexico would crater the U.S. growth outlook expectations and probably plunge the U.S. economy into recession as well, which is an outcome that Trump is unlikely to want to risk if his intention is to virtue signal.

Canada’s Globe and Mail reported about a different study by the Canadian Chamber of Commerce’s Business Data Lab which estimated Canadian GDP would fall -2.6% and U.S. GDP by -1.6%, which would be recessionary. In addition, many U.S. companies with cross-border supply chains will be affected, which will result in significant U.S. job losses.

Expect the stock market vigilantes to force a further face-saving backtrack in the near future.

Trust the Trump Put

The current environment suggests that traders should adopt a strategy of “buy the dip and sell the rips”. The combination of negative surprises during earnings season and potential bearish policy announcements when the market is overbought will put downward pressure on stock prices. On the other hand, investors should trust the stock market vigilantes to activate the Trump Put in the event of a market downdraft, as he judges his own performance by the stock market. In the absence of a severe bearish catalyst, expect stock prices to bounce when the market becomes oversold.

So where does that leave us today? The S&P 500 is near overbought and sentiment, as measured by put/call ratio, is showing signs of froth, which argues for light bearish positioning for trading accounts.

As well, the relative volume of the NASDAQ to NYSE (blue line) is turning down, which is often a sign of impending weakness in the NASDAQ 100. The key question for traders is whether the S&P 500 can hold up if the Magnificent Seven were to falter.

Finally, the Citi Panic/Euphoria Model is off-the-charts euphoric, though it’s not very predictive of equity returns of time horizons of less than a year.

In conclusion, traders should adopt a strategy of “buy the dip and sell the rips”. Lighten or short positions when the market is overbought. On the other hand, investors should trust the stock market vigilantes to activate the Trump Put in the event of a market downdraft.