Waiting for the next market catalyst

Posted by Cam Hui -
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 -
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: Neutral (Last changed from “bullish” on 17-Jan-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 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.
 

A long-term sell signal?

Posted by Cam Hui -
I warned last week about a possible long-term sell signal from my market timing indicator, but I wasn’t willing to front run my models as the month hadn’t ended yet. Now it’s happened. A long-term sell signal has been triggered.

 

As a reminder, this long-term timing indicator buys when the monthly MACD (bottom panel) turns positive and sells when the 14-month RSI of the NYSE Composite (top panel) flashes a negative divergence. Now that the month of January is over. The S&P 500 rose to a marginal closing high on a monthly basis, but the 14-month RSI is exhibiting a lower high, which qualifies as a sell signal.

 

 

No model is perfect and this sell signal should be regarded as a warning and not actionable trading advice. I interpret this signal as the warning of a possible major market top in Q1 or Q2. From a tactical perspective, I am inclined to monitor other indicators on different investing dimensions for signs of a tactical tipping point that the bears are taking control of the tape.
 

 

Market breadth warnings

The most worrisome technical development is the lack of breadth participation in the latest advance. Even as the S&P 500 reached another all-time high, none of the Advance-Decline Lines have been able to exceed their previous highs that were set in late November. But A-D Line divergences can persist for months before the market’s actual high. This represents just another warning and not a tactical sell signal.
 

 

Rather than just measuring market breadth on an aggregate stock basis, SentimenTrader measured breadth on a sector basis and found that the latest advance was very restricted, which tended to lead to high levels of uncertainty and subpar returns.
 

 

While many investors have compared the current era to the dot-com bubble, which was composed mainly of unprofitable companies with strong growth outlooks, the current instance of breadth deterioration is more reminiscent of the Nifty Fifty top. That era was dominated by the leadership of a few large-cap profitable and fast-growing companies. The top was preceded by breadth divergences, which ultimately resolved with a major bear market.
 

 

The bond market’s verdict

Mark Hulbert recently documented the off-the-charts level of valuation for U.S. equities. But valuation metrics tend to predict long-term 10-year returns and are ineffective over shorter 1-year horizons.
 

 

With valuations so stretched, investors should pay attention to the bond market, which could be in the driver’s seat of equity returns. The bond market’s risk appetite can be decomposed to several components.
 

The first component is the term premium, or the compensation investors demand to extend the maturity of a bond. Right now, term premiums have risen to a new cycle high, but there are no signs of panic or a stampede for the exits.
 

 

Another way of thinking about the term premium is to view it through the inflation expectations lens. The accompanying chart shows the relative performance of TIPs against a long-dated zero-coupon Treasury bond. The inflation factor recently staged an upside breakout to a fresh high, but pulled back below resistance. Is this the case of a glass half-full or half-empty?
 

 

The last signal from the bond market is the pricing of high leverage equities, as measured by effective junk bond yields, which are estimated using the blue and red lines in the accompanying chart. Currently, junk bond funding costs are slightly elevated but remain in the middle of a range, indicating few levels of anxiety.
 

 

 

Policy wildcards

Finally, I am monitoring the effects of Trump’s new policy directions which are largely unknown at this point.

 

Two key questions come to mind. I discussed the outsized effects of Trump’s deportation policy last week (see Two Key Risks to the Bull That No One Is Talking About). Will the scale of the deportations be as significant as promised or will they be largely be cosmetic in nature?

 

Finally, how will Trump wield the tariff tool? Specifically, what will the relationship be with China?
 

The early indications show that Trump is using tariffs as a blunt negotiation tool against allies to extract concessions unrelated to trade (see Denmark/Greenland, Panama, Mexico and Canada). He appears to have signaled his willingness to make a deal with China based on his TikTok decision, and his threat to impose tariffs on semiconductors made in Taiwan, which has significant geopolitical implications that go well beyond trade.

 

As for the announced tariffs of 25% on Canada and Mexico, I 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. The headline reasoning for the tariffs is the amount of fentanyl crossing U.S. borders. The accompanying chart shows the history of fentanyl seizures. The amount seized at the Canadian border in 2024? 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 accounted 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%. 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.

 

The following chart summarizes the market’s reaction to Trump’s tariff threat. The USD initially rose strong on the fear of large-scale tariff imposition, based on the expectation that the currencies of America’s trading partners would devalue to offset the effects of tariffs. The USD later retreated when Trump’s tariff threat turned out to be worse than his bite. The volatility in the currency markets is occurring against signals of weak global cyclical strength, as measured by the base metals to gold ratio (black line) and copper to gold ratio (red line). The combination of USD strength and weak global cyclical demand is not conducive to the price of risk assets like equities.
 

 

The lack of strength from global cyclical indicators is reflected in the latest PMI surveys from China. Activity is steady, but shows no signs of acceleration or deceleration. As China forms one of the three triumvirates of global growth, the lack of a Chinese cyclical recovery matters for equity prices.

 

 

In the absence of clarity on trade, John Authers highlighted analysis from China Beige Book, which concluded that Beijing is not inclined to stimulate its economy, even if it has the capacity to do so [emphasis added]:

Our data indicate Beijing feels little pressure to unleash historic levels of stimulus spending, even if it’s capable of doing so. Current accommodating words and inactions from Trump on tariffs reinforce that view.

In conclusion, breadth indicators are flashing early cautionary signals for U.S. equities, but these signals can often be early in calling a major market top. A review of other indicators on different investing dimensions are either benign or cautious. I interpret this as the warning of a possible major market top in Q1 or Q2. Investors should monitor risk appetite indicators for tactical signs to turn cautious.

 

Waiting for the gaps to fill

Posted by Cam Hui -
Mid-week market update: I know that I expected market volatility, but I didn’t expect the immediate source of volatility to be anxiety over DeepSeek. I should have known better when my physiotherapist, who didn’t know I worked in finance, started to talk about NVIDIA this week.

 

You can tell a lot about the character of a market by how it responds to sudden price gaps. The DeepSeek sell-off left a gap in NVDIA’s stock price. Now that the dust is starting to settle out over the news, the strength of the AI and semiconductor investment themes will depend on whether the gap gets filled.

 

 

 

The DeepSeek freakout

In case you missed it, here is a brief summary of the DeepSeek freakout. A Chinese VC financed AI startup announced that it had achieved a breakthrough in large language model (LLM) processing. By taking a number of “good enough” shortcuts, it was able to achieve similar LLM results with 1/30th of the processing power used by the hyperscalers building the current generation of LLMs. DeepSeek was able to achieve this breakthrough using open source code. Even if you were to shun the company’s product owing to its Chinese connections, it wouldn’t take much for a parallel startup to build out a similar product and achieve similar low-cost results.

 

The bear case brings up memories of the crash in the stock of Cisco Systems during the dot-com crash. There was a scramble to build fibre optic capacity during the heady days of the parabolic growth of the internet in the late 1990’s. One vendor, Cisco, made routers that formed the backbone of the internet. Cisco had a near monopoly on their product and their margins were astronomical. The reckoning resolved in excess capacity, and customers rushed to dump their Cisco routers on the market, which cratered the company’s sales.

 

Fast forward to today. Another company holds a near monopoly on advanced chips for AI processing and it’s enjoying astronomical margins in a market that’s experiencing parabolic growth. Since DeepSeek’s breakthrough was achieved with lower quality and slower NVIDIA chips with lower margins that are at risk of commoditization, will NVIDIA suffer the Cisco experience?

 

The bulls believe that there will always be increasing demand for faster and faster processors, and the DeepSeek innovation will expand demand for computing. The open question is what happens to demand and margins.

 

As earnings season proceeds, investors will be closely scrutinizing the capex plans of the AI hyperscalers, starting with Microsoft and Meta after the close of market today.

 

 

From a broader perspective, the DeepSeek freakout left the Semiconductor Index testing key levels of absolute and relative support. In addition, Trump’s recent threat to impose tariffs on semiconductors coming from Taiwan didn’t help the group either.

 

 

 

Constructive patterns

From a broader perspective, the S&P 500 filled the gap left by the DeepSeek selloff, but a price gap below remains unfilled, which is a constructive pattern. However, the market is near overbought, as measured by the percentage of S&P 500 stocks above their 20 dma (bottom panel).

 

 

While I have voiced some concerns about market breadth, breadth indicators are neutral in the short run.

 

 

 

The Fed non-event

 

Then we have the Fed decision, which turned out to be a non-event. The Fed left rates unchanged, which was widely expected. The FOMC statement was initially interpreted as slightly more hawkish. The inflation reference on “made progress toward the…2% objective” was dropped, but Powell discounted the effects of the change during the press conference as cleaning up the language in the FOMC statement.

 

 

The 10-year yield rose in response to the statement release by retraced most of the gains after Powell’s clarification.
 

 

I interpret these results as a data dependent Fed, and the market may experience some volatility as changes in the data affect expectations. The market continue to discount the next rate cut as occurring in June.

 

 

In conclusion, the financial markets will continue to experience choppiness in response to new developments, which are unpredictable. However, the structure of the technical picture continues to appear constructive in the short run, notwithstanding further surprises from Big Tech and Trump policy announcements.

 

Tips on navigating the post-inauguration rally

Posted by Cam Hui -
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: Neutral (Last changed from “bullish” on 17-Jan-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.

 

 

Time for a pause?

January is almost over, and the S&P 500 staged an upside breakout to an all-time high last week, which Jeffrey Hirsch found is consistent with market seasonality. If the seasonal patterns found by Almanac Trader were to continue, stock prices are likely to be flat to down in February.
 

 

The rally left the market overbought, as measured by the NYSE McClellan Oscillator (NYMO). This is not necessarily bearish. Of the nine instances in the last three years when it reached 70 or more, stock prices retreated on three occasions and either advanced or consolidated sideways in the other six.
 

 

 

Supportive sentiment

In addition, short-term sentiment readings are not excessively bullish. The AAII weekly bull-bear spread is positive at 14, but don’t represent a crowded long. These readings leave the bulls more room to run should the backdrop prove to be favourable.
 

 

Bloomberg reported that positioning is light and institutions are skeptical of the rally:

A measure of aggregate positioning among rules-based and discretionary investors fell to a two-month low, according to Deutsche Bank AG’s data. And commodity trading advisors cut their long stock exposure to the level last seen in the aftermath of a market rout in August, data compiled by Goldman Sachs Group Inc.’s trading desk show.
From a contrarian perspective, such skepticism bodes well for stock-market bulls because it means more dry powder to buy equities down the road, should the biggest fears fail to materialize. While political uncertainty weighs heavily on investor sentiment, inflation has been subsiding and fourth-quarter earnings season is off to a strong start.

Barring any negative surprise, my base-case scenario calls for some near-term choppiness and, at worse, a shallow pullback to the 50 dma, which represents downside risk of only 2% on the S&P 500.
 

 

A case of bad breadth

While the short-term outlook for stock prices appear looks like it’s flat to up, I have some concerns about the intermediate-term trend. That’s because of the growing negative breadth divergences. Even as the S&P 500 broke out to an all-time high, none of the Advance-Decline Lines confirmed with a fresh high.
 

 

Breadth divergences can be measured in other ways beside the A-D Line. A rapid decline in the percentage of S&P 500 stocks above their 200 dma can be signals of a substantial decline.
 

 

To be sure, negative breadth divergences are warnings and not immediate sell everything signals. Negative breadth divergences can take months to resolve before the bears take control of the tape.
 

 

 

Near-term consolidation ahead

My base-case scenario calls for some near-term consolidation or shallow pullback. An analysis of the relative performance of the top five sectors by weight in the S&P 500 shows no strong co-ordinated bullish or bearish trends. As these sectors represent about 70% of index weight, the index needs broad-based participation for the S&P 500 to either rise or fall.
 

 

In conclusion, the S&P 500 is short-term overbought after breaking out to an all-time high and needs time to digest its gains. I expect this will resolve in a period of sideways consolidation or shallow pullback, though the combination of the uncertainty of Q4 earnings season reports, with 37% of S&P 500 expected to report, and the upcoming FOMC and ECB rate decisions could induce some volatility. However, I have substantial concerns over growing signs of negative breadth divergences, which could be signals of a cycle top in either Q1 or Q2.

 

 

Two key risks to the bull that no one is talking about

Posted by Cam Hui -

The S&P 500 has been in a steady uptrend for over two years and it just staged an upside breakout to an all-time high. It may seem counterintuitive to be discussing the risks of a major market top, but I am seeing some early warnings that few analysts are paying attention to.
 

 

 

The roots of its own demise

While I am not inclined to front run model readings, if the S&P 500 were to end January at a closing high, it would represent the roots of a bullish demise.

 

The accompanying chart shows a long-term buy and sell discipline that has served us well over the years. Here is how it works. A buy signal is triggered when the monthly MACD of the NYSE Composite (bottom panel) turns positive (dotted blue vertical lines). A sell signal is triggered when the 14-month RSI (top panel) flashes a negative divergence when the market makes a new high. If the S&P 500 were to close the month at current levels, it would represent a new monthly high, while the 14-month RSI is making a lower high, or a sell signal.

 

 

While it is said that there is nothing more bullish than a stock or index making a fresh all-time high, this might be an exception to that adage. In this case, weak RSI momentum is setting up the bulls with the roots of their own demise.
 

The weakness in NYSE Composite RSI is reflective of the weak breadth exhibited by the stock market. Even as the S&P 500 tests overhead resistance at its all-time high, no version of the Advance-Decline Line is nearing a fresh high.
 

 

It could be argued that my long-term model readings, which are based on the NYSE Composite, are misleading as the S&P 500 has been outperforming the NYSE Composite because of the strength of the Magnificent Seven. A similar monthly analysis based on the S&P 500 also shows a less pronounced but still negative RSI divergence.
 

 

To be sure, negative RSI divergences and negative breadth divergences are not immediate sell everything and rush into cash signals. Instead, they are warnings of faltering momentum, but these readings are warning of a potential Q1 or Q2 market top. The caveat is this is a monthly model and investors need to monitor how the market closes at the end of January.
 

MarketWatch recently also reported another long-term warning with no immediate bearish trigger. Ed Yardeni found that foreigners, who have a terrible market timing record, are piling into U.S. equities at a record pace.
 

 

 

The deportation growth threat

Markets turned risk-on after Trump’s inauguration, largely because many of the potential headwinds to growth did not immediately materialize. While Trump did sign a flurry of executive orders, most of them were either symbolic, cultural or only had economic effects that didn’t unsettle markets, such as the reversal of DEI initiatives, renaming the Gulf of Mexico and the withdrawal from the Paris Accords.
Trump didn’t immediately slap tariffs on China, though he did threaten Canada and Mexico with 25% tariffs and China with 10% by February 1, which the market interpreted as bluster. It seems that Trump 2.0 learned from the lessons of Trump 1.0 and the chaos of the Muslim ban when Trump first took office in 2017. The new Trump Administration is being more measured in the implementation of its campaign promises.

 

One of Trump’s signature initiatives is on deportation as he vowed in his inaugural address to send “millions and millions of criminal aliens back to the places from which they came.” The Peterson Institute estimated the effects of Trump’s major electoral promises in a study. It modeled the effects on GDP and inflation of light (1.3 million people) and severe deportation (8.3 million) over a four-year window, as well as the effects of different tariff rates and the revocation of Fed independence. The magnitude of the effects on growth and inflation of deportation is substantially higher than either tariffs or the revocation of Fed independence.

 

 

A different study by the Brookings Institute projected less alarming effects on growth, though there are different approaches to the two studies. The Peterson study projected the effects over four years and analyzed pure deportations, while the Brookings study modeled the effects in 2025 and focused on net migration, which includes the natural effect of legal immigration plus the negative effects of deportations.
 

The Brookings study, which assumed an extreme scenario of a mass deportation of over one million people in 2025 is reminiscent of the Eisenhower deportations of 1954, modeled a one-year GDP growth shock of -0.4%. To make an apples-to-apples comparison to the Peterson study, its assumption of the removal of 1.3 million illegals caused a negative GDP growth shock of -3.8% over four years, which averages to just under -1% a year.
 

 

Any way you look at it, there will be a negative growth surprise from mass deportation. Economists can make various assumptions in modeling but won’t know until it actually happens.

 

So far, the Trump Administration is taking more disciplined measured steps to implement its campaign promises. The House just passed the Laken Riley Act, which will deport illegal immigrants charged, but not necessarily convicted, with certain crimes. The Act is certain to be signed into law by Trump, though it’s unclear whether it will survive a court challenge because it denies due process to deportees. While there were stories of scheduled immigration raids in sanctuary cities like Chicago and San Diego, the raids have been put on hold, though there were a raid reported in Boston. In short, the extent and scale of deportation efforts remains to be seen. If the measured pace of Trump 2.0 continues, investors will see more substantial signs of deportation by Q2 or Q3. This is consistent with the scenario of a cyclical stock market top in Q1 or Q2 signaled by negative breadth divergences, as markets tend to be forward-looking.
 

So far, two industries that depend on undocumented worker labour, homebuilding and restaurants, have lagged the S&P 500 but price action shows increasing concern but no panic.
 

 

In conclusion, nascent signs of a major market top are appearing even as the S&P 500 tests its all-time high. A growing negative breadth divergence and a potential growth shock of mass deportations could sideswipe stock prices. The scenario of a major market top in Q1 or Q2 2025 is building. The caveat is these are very early and preliminary warning signs of risk that should be monitored before taking action.

 

The Trump Put lives!

Posted by Cam Hui -
Mid-week market update: Trump promised a flurry of executive orders to implement his campaign promises on the first day he took office. Amidst the flurry, the market breathed a sigh of relief as there were no major risk-off catalysts. The market is apolitical and it doesn’t care about the reversal of DEI policies, or whether a mountain in Alaska is named Denali or McKinley. Although there were threats of 25% tariffs on Canada and Mexico, and a 10% tariff on China, both to be put in place on February 1st, there were no instant tariffs that would have rattled markets.

 

Trump showed during his first term that he cared about the stock market. As he begins his second term, the Trump Put seems to be alive again.

 

As a consequence, the S&P 500 is testing its all-time high at about 6100. Even though readings are overbought, this could be a “good overbought” advance that takes the market to new highs, with upside potential at the dotted resistance line measuring at about 6300 by the end of January. On the other hand, it’s disconcerting to see a breadth indicator such as the percentage above the 20 dma (bottom panel) fall on a day the market is testing its all-time high.

 

 

Here are the bull and bear cases.

 

 

Sentiment isn’t stretched

An analysis of institutional sentiment, as measured by BAML Global Fund Manager Survey, shows that respondents are bullish, but conditions aren’t extreme. Stocks could continue to rally from here.

 

 

Trump’s decision on the TikTok ban was even more encouraging for the bulls. As a reminder, Congress passed a law forcing TikTok’s Chinese parent ByteDance to either shut down or divest TikTok by last Sunday. The bill was signed into law by Biden and upheld by the Supreme Court in a 9-0 decision. Trump, who originally opposed TikTok’s U.S. presence, changed his mind and signed an executive order delaying the ban for 75 days. More importantly, he left the door open for TikTok to continue to operate if the U.S. government could take a 50% stake in the company.

 

Combined with the absence of immediate tariffs on China, the TikTok decision was a signal to the Chinese government that Trump was willing to make a deal. The less threaten tone against China also raises the odds of a China growth recovery, which is the BAML Fund Manager Survey’s biggest possible bullish surprise.

 

 

 

Weakening breadth

I had been encouraged by evidence of broadening breadth in the market, but today’s test of key resistance is being accomplished on narrow breadth. While breadth divergences can last for months before stock prices take a stumble, this is an unwelcome development for the bulls.

 

 

Another concern is the bond market, whose rally had underpinned the latest risk-on episode. Bond prices are stalling at resistance, which is another warning sign.

 

 

 

A complacent market

So where does that leave us? While the Trump Put is probably in place, traders can’t rely on it as unexpected policy announcements and individual company’s results during Q4 earnings season could induce volatility at any time. In the meantime, the market looks complacent. The accompanying chart shows the implied volatility (IV) of near-the-money SPY options that expire on January 31, 2025. The top panel shows the closing IV readings as of January 17, 2025, the Friday before Trump’s inauguration, and the bottom panel shows the latest figures. IVs are flat to down, indicating complacency in an environment of uncertainty.

 

 

In conclusion, the S&P 500 could rally above resistance at 6100 and end the month significantly higher, but I am inclined to be cautious and fade any upside breakout. Uncertainty is high and the market is an accident waiting to happen. At the same time, my inner trader isn’t inclined to actively take a short position in the face of possible rampage of the animal spirits.

 

What a changing of the guard means for stocks

Posted by Cam Hui -
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: Neutral (Last changed from “bullish” on 17-Jan-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 bond market reversal

Last week, I highlighted the risk-off tone caused by the bond market tantrum that was under way. As the week progress, softer-than-expected PPI and CPI reports calmed the bond market vigilantes and yields retreated.
 

 

The reversal occurred just in time for the changing of the guard at the White House.
 

 

In search of policy clarity

While the rally in bond prices (and decline in yields) was constructive, it left Fed Funds policy expectations unchanged. The market continues to expect just one rate cut in 2025, with the first one occurring mid-year. In effect, the bond rally amounted to a reduction of the tail-risk of a Fed pivot to either stopping rate cuts or even raising rates in response to runaway inflation.
 

 

As Trump takes office, expectations had been building for his policies. But volatility risk will stay high until investors see some actual clarity and concrete actions by the new administration.

 

Treasury Secretary designate Scott Bessent offered some guidance on Trump’s economic policies when he testified at his Senate confirmation hearing. Bessent confirmed that Trump will impose tariffs, though the implementation timeline is unclear. There are three reasons for tariffs. The first is to remedy unfair trade; the second is to raise revenue for Treasury; and the third is a tool to negotiate with other countries, such as Trump’s threat to impose 25% tariffs on Canada and Mexico if they didn’t address U.S. border issues.

 

In addition, Bessent affirmed that the Trump Administration is committed to the extension of the TCJA tax cuts and called it “the single most important economic issue of the day”.Now that the market is starting to see some policy clarity, what will the upcoming changing of the guard bring?

 

 

How far can the rally run?

Let’s assess how equity market conditions have evolved. I was pounding the table that the market was oversold and poised for a relief rally. The relief rally began last week and it was sparked by the bond market rally.

 

Conditions aren’t oversold anymore. The S&P 500 is broke through overhead resistance at its 50-dma and falling trend line (dotted line). Moreover, some indicators, like the NYSE McClellan Oscillator, have reached an overbought extreme. Other indicators, such as the percentage of S&P 500 above their 20 dma, have exceeded my minimum upside target of 65%.

 

Can the market rally further?

 

Certainly. The S&P 500 rose 1% Friday, which qualifies as an IBD follow-through day, indicating positive momentum. However, Friday’s rally was slightly unconvincing as it was accomplished with a doji candle, signaling indecision and possible trend reversal. The next upside target for the S&P 500 is its all-time high at about 6100. Additional resistance can be found at the rising trend line (dotted red line) at about 6300.

 

 

Before the bulls become overly excited, let’s take it one step at a time.
 

 

Where’s the fear?

I have been concerned about the lack of extreme fear during this latest oversold episode.

 

The stock market was extremely oversold in December, but option sentiment showed no evidence of a fear spike in the put/call ratio that was in evidence at recent tactical bottoms.

 

 

The AAII weekly sentiment survey is showing similar readings of elevated concern, but no panic.
 

 

 

No compelling buy signals

The lack of fear during this latest oversold episode is an argument that the relief rally is likely to fizzle sooner rather than later.
 

To be sure, technical conditions are constructive but there are no compelling buy signals. Breadth is broadening out, which is helpful to the bull case.
 

 

A review of insider activity did not show strong insider buying in the December downdraft, when insider buying (blue line) exceeded insider selling (red line). While the lack of insider buying isn’t necessarily bearish, it does give support to the case that the relief rally may not be sustainable.
 

 

As well, risk appetite indicators present a mixed picture. The relative performance of junk bonds is bullish, while the relative performance of high beta to low volatility stocks yields a neutral signal.
 

 

The lack of small-cap strength during a period of seasonal strength for smal-cap stocks is equally concerning.
 

 

Lastly, the negative divergence in the extreme animal spirits tail of the market is disconcerting. Bitcoin is rallying based on the cryptocurrency friendly policies of the Trump Administration.. Bitcoin prices had been correlated with the relative performance of speculative growth stocks, as measured by the ARK Investment ETF. In the current instance, speculative growth is exhibiting a series lower lows and lower highs.
 

 

In conclusion, much of the gains from the relief rally that I called for are likely in the rear-view mirror. The lack of extreme fear during this latest oversold episode makes me question the longevity of the rally. In light of the uncertainties posed by the changing of the political guard in the U.S., the prudent course of action for traders is to step aside and wait for greater clarity before taking further action.

 

In the coming week, the market is likely to focus on the new directions of the new Trump Administration. The downside risk of Trump’s signature electoral promises, such as the negative growth from tariffs and deportations, can be implemented immediately with executive orders, while the upside potential of his pro-growth policies, such as the tax cut extension and deregulation, need legislative approval that depend on a razor-thin House majority.

 

As we saw with the H-1B decision, some Trump constituents are likely to be disappointed, and the potential for market disappointment is elevated.