High drama at the 200 dma

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: Bullish (Last changed from “neutral” on 28-Feb-2025)

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

Subscribers can access the latest signal in real time here.

 

 

A test of the 200 dma

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

 

 

Nearing a short-term bottom

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

 

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

 

 

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

 

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

 

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

 

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

 

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

 

 

 

A de Gaulle or Liz Truss moment?

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

 

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

 

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

 

 

 

Trade war uncertainty

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

 

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

 

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

 

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

 

 

 

All systems (almost) ready

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

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

 

 

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

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

 

 

My inner trader is maintain his long position in the S&P 500. The usual disclaimers apply to my trading positions.

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

 

 

Disclosure: Long SPXL

 

Tops are processes

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

 

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

 

Negative divergences

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

 

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

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

 

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

 

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

 

 

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

 

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

 

 

Fiscal headwinds

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

 

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

 

 

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

 

 

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

 

 

Trade war headwinds

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

 

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

 

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

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

 

 

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

 

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

 

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

 

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

 

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

 

 

 

The silver lining

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

 

A guide to market bottoms, and what kind

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

 

 

 

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

 

 

Condition indicators

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

 

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

 

 

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

 

 

 

Sentiment as trading signals

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

 

 

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

 

 

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

 

 

 

Bottom Spotting Model

Let’s review the components of my Bottom Spotting Model, which is a mix of oversold and sentiment models with different time horizons.
VIX Index: VIX rising above its upper Bollinger Band (triggered). This is an indication of a short-term oversold condition.
VIX term structure:  Inverted (see above discussion).
NYSE McClellan Oscillator:  Fell to below -50, which is a short-term oversold condition that usually leads to a bounce.
TRIN:  When TRIN spikes above 2 at the end of the day, it’s an indication of price-insensitive selling, otherwise known as a margin clerk (or risk manager) market. Such events usually occur at the end of sell-offs. This condition hasn’t been triggered.
Intermediate term OB/OS:  This is an intermediate-term overbought/oversold oscillator using the 50 and 150 dma. Triggers of this indicator are indicative of a durable intermediate-term bottom. This hasn’t been triggered.

 

 

 

Bottom durability

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

 

 

My inner trader continues to hold a long position in the S&P 500. A short-term bounce is ahead, but don’t expect much more than that. The usual disclaimers apply to my trading positions.
I would like to add a note about the disclosure of my trading account after discussions with some readers. I disclose the direction of my trading exposure to indicate any potential conflicts. I use leveraged ETFs because the account is a tax-deferred account that does not allow margin trading and my degree of exposure is a relatively small percentage of the account. It emphatically does not represent an endorsement that you should follow my use of these products to trade their own account. Leverage ETFs have a known decay problem that don’t make the suitable for anything other than short-term trading. You have to determine and be responsible for your own risk tolerance and pain thresholds. Your own mileage will and should vary.

 

 

Disclosure: Long SPXL

 

A golden opportunity

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

 

 

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

 

 

Negative seasonality

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

 

 

 

A long-term breakout

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

 

 

 

Inflation ahead

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

 

 

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

 

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

 

 

What should you buy as the Magnificent Seven falters?

Posted by Cam Hui -
Preface: Explaining our market timing models

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

 

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

 

 

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

 

The latest signals of each model are as follows:
  • Ultimate market timing model: Buy equities (Last changed from “sell” on 28-Jul-2023)
  • Trend Model signal: Neutral (Last changed from “bullish” on 15-Nov-2024)
  • Trading model: Bullish (Last changed from “neutral” on 28-Feb-2025)

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

Subscribers can access the latest signal in real time here.

 

 

The end of American Exceptionalism?

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

 

 

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

 

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

 

The Big Picture

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

 

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

 

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

 

 

Not so magnificent anymore

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

 

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

 

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

 

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

 

 

Make Europe Great Again

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

 

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

 

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

 

 

An unconvincing rally

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

 

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

 

 

Key risk

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

 

 

The week ahead

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

 

 

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

 

 

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

 

 

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

 

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

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

 

 

Disclosure: Long SPXL

 

Bessent gets his wish, but not in a good way

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

 

 

 

Fragile and unbalanced growth

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

 

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

 

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

 

Uncertainty = Weak capex and hiring

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

 

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

 

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

 

 

Weakening housing

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

 

 

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

 

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

 

 

Not the Apocalypse

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

 

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

 

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

 

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

 

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