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The latest FOMC statement and subsequent press conference were full of references to “uncertainty”. Most notably, the FOMC statement changed the language related to the Fed’s goals being “roughly in balance” to “uncertainty around the economic outlook has increased”. Not only is uncertainty elevated, but also the risks to inflation, GDP growth and […]
Is it time to ask, “Who’s left to sell?”
Similarly, Goldman Sachs prime brokerage revealed a similar pullback in long/short hedge fund positioning.
It’s not just the long/short funds. Commodity Trading Advisors (CTAs) are in a crowded short in U.S. equities. Any hint of market strength will spark a short covering buying stampede.
At a minimum, these sentiment readings should put a floor on stock prices.
At a single-stock factor level, price momentum ETFs are all showing turnaround signs after their recent sudden collapse.
The FOMC decision had something for both bulls and bears, hawks and dove. It revised its forecast inflation rate up, unemployment up modestly, GDP growth down from 2.1% to 1.7% in 2025, and the median dot plot was unchanged, though the dot plot range rose. More importantly, the Fed reduced the rate of quantitative tightening, or the reduction in the size of the Fed’s balance sheet, which amounts to a form of stealth liquidity injection into the banking system.
Bottom line: The path of least resistance for stock prices is up, but be prepared to see the S&P 500 re-test its recent lows. My inner trader is maintaining his long position in the S&P 500. The usual disclaimers apply to my trading.
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.
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.
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?
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.
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.
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.
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.
Here is what I am watching.
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.
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.
It’s still an open question, however, whether these developments are enough to push the economy into a recession, or just a slowdown.
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 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.
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.
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.
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.
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).
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?
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.
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 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.
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.
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.
Notwithstanding the technical patterns of a possible topping market, U.S. equities face a number of macro headwinds.
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.
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.
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.”
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.
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.
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%.
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.
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.
Should you jump on the gold momentum train, or fade its rally?
This is consistent with the observation of an upward sloping trend in inflation surprise on a global basis.
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.
Is it time for investors to pivot into non-U.S. equities?
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.
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.
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.
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.
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.
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.
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.
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.
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.
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.
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:
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”.
Despite all of the dire news, I am not projecting a recession, just a growth scare and reset of growth expectations.
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.
In the past, such episodes have tended to resolve bullishly.
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.
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.
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.
What could tip the market into a pullback instead of a rolling correction? One headwind that it faces is diminishing banking system liquidity.
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.
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.
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.
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?).
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.
Where will the rebound in growth come from?
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.
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 institutions are all-in on risk. Who’s left to buy?
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.
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.
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.
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.
In addition to the negative breadth divergence, I am seeing other divergences everywhere.
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.
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.
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.
Beyond the bullish outlook on the yellow metal, here are the asset return implications.
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.
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:
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 market seems to be ignoring tail-risk, which is an increasingly worrisome development.
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.
Similarly, the stock market didn’t react to trade war in 2017-2018 until it stared the news in the face.
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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.
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.
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.
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.
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.
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 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.
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.
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.
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.
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 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.
