End of the Beginning

By: Michael Coolbaugh, Chief Investment Officer

*The following note is a partial sample of our weekly report. This was published for clients on April 1, 2025.

It was only fitting that March finished off with an insane intraday reversal given how eventful Q1 of 2025 has been. I’ll admit, when I sat down at my computer yesterday morning and saw the set-up, I thought it’d be best to hold off on our weekly report until today. Here’s why…

Over the weekend, the chorus has grown louder that the administration’s tariff policy will act as a major drag on growth. For us, this thinking isn’t new. In fact, we’ve been talking about this for several months now. Investors ignored it all throughout January. Denied it in February. And it was only in the closing days of March that people suddenly began to realize that the Trump administration is serious about its tariff policy.

Here’s the thing… Everyone was convinced that Trump’s apparent softening on tariffs with, “there will be flexibility” at the end of the second week of March, was a sign that the ‘Trump put’ was alive and well. Equities ripped higher into the underside of the 200-day moving average (at least for the S&P 500 and NASDAQ), only to get smacked in the face when President Trump moved forward with auto tariffs.

But what sparked such a vicious sell-off last Friday? Yields, all across the curve, fell and equities puked. To me, this wasn’t about the PCE data which actually came in slightly hotter than expected. No, the fact that bonds shrugged off this inflation print suggested that investors were finally becoming worried that the tariff threats were real. Perhaps it was President Trump stating that the auto tariffs would “remain in effect for the entirety of his term”.

All justifiable concerns. But here’s why we were tactically trimming some of our short exposure yesterday… I started to hear rumblings that “major HF traders” were concerned about the real possibility of a “crash”. Jim Cramer shared on CNBC that, “I can’t think of a dumber day to buy stocks than today.” Even the “expert macro strategists” all over FinTwit, who had been raging bulls throughout this entire decline because of “massive productivity gains” and “never bet against the USA”, were starting to acknowledge that the behavior between stocks and bonds on Thursday was a sign that growth fears are becoming a real concern.

Is a crash possible? Sure. What are the odds? I have no idea. But after the past four years, people have become conditioned to think of equities in binary terms - “straight up and to the right” or “crash”.

To me, the more painful scenario would be a miserable sideways-to-lower grind where true panic never really sets in. One where people continue to cling on to hope that tariffs won’t be as aggressive as the administration says. One where brief moments of optimism about “tax cuts” or “bank deregulation” will take people’s attention away from a slowing economy.

Why do I expect a slowing economy? Well, the data already suggests that economy was beginning to slow even before these latest tariff fears. But as I shared before, I do believe the tariffs will be implemented and there won’t be some sudden rollback because of a magical “Trump put” for equity prices. The reason being – this administration truly believes that tariffs are a way to generate revenue and cut into the deficit. Cut into the deficit that will allow them to extend tax cuts. This isn’t Trump 1.0 where tariffs were being used strictly as a negotiating tactic. There is a strong fundamental belief that tariffs are good, tariffs will drive investment here in the United States, and tariffs will generate massive amounts of revenue for our government.

The major difference between Trump 2.0 and Trump 1.0 comes from the people in his inner circle. During his first term, President Trump surrounded himself with the likes of Gary Cohn and Steve Mnuchin – two people who were staunch critics of tariffs. In this term, there’s very little question that Howard Lutnick, Kevin Hassett and Scott Bessent support Trump’s desire to implement tariffs (while Bessent has been an advocate of a more measured, gradual approach, he’s certainly not a voice strongly pushing against the use of them entirely).

But here’s the thing… Tariffs will raise prices. Those higher prices will cut into demand from a consumer that has already shown signs of being “tapped out”. Those higher prices will create a difficult balancing act for the Fed, who would love to be aggressively cutting at any sign of a slowdown. It’s why we’ve heard so many members preach the importance of patience and how “the current holding stance is the correct one.”

There’s also the uncertainty of all this. Sure, there are some large corporations that have thrown around large multi-year investment plans here in the United States. But for the rest of small- and medium-sized enterprises, there are very few alternative options. Here’s just a few brief quotes from the Dallas Fed Survey on the energy industry…

“The administration’s tariffs immediately increased the cost of our casing and tubing by 25% even though inventory costs our pipe brokers less. U.S. tubular manufacturers immediately raised their prices to reflect the anticipated tariffs on steel. The threat of $50 oil prices by the administration has caused our firm to reduce its 2025 and 2026 capital expenditures. “Drill, baby, drill” does not work with $50 per barrel oil. Rigs will get dropped, employment in the oil industry will decrease, and U.S. oil production will decline as it did during Covid-19.”

“I have never felt more uncertainty about our business in my entire 40-plus year career.”

“Uncertainty around everything has sharply risen during the past quarter. Planning for new development is extremely difficult right now due to the uncertainty around steel-based products. Oil prices feel incredibly unstable, and it’s hard to gauge whether prices will be in the $50s per barrel or $70s per barrel. Combined, our ability to plan operations for any meaningful amount of time in the future has been severely diminished.”

You see, tariffs don’t just raise the cost of imported products. If a domestic supplier knows he/she can raise prices by 20% and still be cheaper than foreign competitors, the natural reaction function is to do so immediately. Why wouldn’t you raise prices to capture a larger profit margin?

What’s more is people still believe April 2nd to be more of a “beginning of the end” to tariff drama instead of the “end of the beginning.” While much of the focus has been on the ability for other countries to cut tariffs and thus allows the US to reduce reciprocal tariffs, very few expect retaliatory tariffs from our trading partners. What happens if Canada, as Mark Carney has stated, does indeed implement reciprocal tariffs? What if Europe slaps additional tariffs on US tech’s “digital services”? Does President Trump ratchet up tariffs on both countries? In my opinion, April 2nd is only the starting gun.

And then there’s the uncertainty that we talked about – not only with respect to tariff policy but on so many other objectives. The administration’s tariff policy completely flies in the face of their plan to lower the price of oil to $50/bbl. And their objective of lowering the price of oil to $50/bbl is entirely contradictory with their mantra of “drill, baby, drill”.

So, yes, it does appear that some investors are finally starting to become concerned with the economic outlook. But all throughout this decline, we’ve only had two major banks lower their year-end targets for the S&P 500 Index (Goldman Sachs and Barclays). It is worth noting, however, that both of their targets still remain well above current levels (after their latest revision, Goldman has joined Barclays with a 5,900 year-end target).

What’s more is the fact that earnings expectations have not budged in the slightest to the downside. If there has been a ‘growth scare’, it’s only been in the contraction of multiples, which still remain well above historical standards. In other words – if we start to see strategists reduce their EPS estimates for 2025/2026, due to the idea that tariff policy will act as a drag on growth, then equities are more expensive than they appear, and further multiple contraction will only put additional downward pressure on equity prices.

And while credit spreads have finally started to show the slightest signs of stress, there is one thing we’ll be watching over the months ahead. As Bloomberg’s Anna Wong points out, approximately 10 million people may experience a major negative hit to their credit scores once the Trump administration allows the Covid-era student loan forbearance to expire. This is another one of those old tailwinds that is now being turned into a headwind as a result of a significant change to fiscal policy. Here’s the research article from the New York Fed.

Ok, ok, these are all things we’ve been talking about for quite some time. So, why in the world were we trimming short exposure yesterday? Well, part of it had to do with all those anecdotal sentiment things I mentioned at the outset. It’s also a tactical measure and not some sudden change in a directional view. But let me expand on some of the data-related items that supported this decision.

For starters, we have a positive momentum divergence on both the S&P 500 and NASDAQ after yesterday’s test of the March 13th lows. Yesterday’s strong reversal to the upside is a welcome sign for bulls hanging on to hope. We also have a positive breadth divergence across all three timeframes (short-, intermediate-, and long-term). We also have the 10-week moving average of “Bears” in the American Association of Individual Investors printing +2 standard deviations above the historical average.

Lastly, we have a positive divergence between the VIX Index and the S&P 500 Index following yesterday’s action. In this case, we saw the VIX only print a high of 24.8 during yesterday’s early-morning sell-off, while the S&P 500 Index and NASDAQ both tested their March 13th lows. For reference, during the week of the March 13th low, the VIX Index hit a high of 29.57.

And that brings me back to something I shared on the last page. Because people still firmly believe that April 2nd is the “beginning of the end”, I wouldn’t be surprised to see an attempt at “sell the rumor, buy the news” (the step-child of “buy the rumor, sell the news”) in equity prices. Where traders throw a bit of a short-term tantrum ahead of “Liberation Day” because they finally realized that the Trump administration is serious about its tariff policy. If investors do believe that April 2nd will be the end of major uncertainty, it’s entirely possible that we see another relief rally.

But if everything that we’ve laid about before, with respect to fiscal headwinds and the possibility of a prolonged tariff war (as laid out in the FT article at the end of this report), does indeed persist; any rally attempt will likely be another solid opportunity for selling.

US Equity Market: The Data and the Anecdotal

By Michael Coolbaugh, Chief Investment Officer

As of this writing, the US equity market appears to be pulling back from what looks to be a feeble attempt at setting new all-time highs (ATHs). The reason I felt it necessary to publish a quick update is because of the general sentiment I’ve been observing over the past several days, coupled with some of the data observations we’ve been discussing with clients.

Before I dive into the data, I’d like to share the anecdotal – the old trading axioms we routinely hear throughout any given day, week, month or year. That axiom? “If a stock, commodity, equity market, etc. can’t fall on increasingly negative news, it’s generally a very bullish signal.” In fact, if you talk to enough traders, you’ll hear them parroting this line given the resilience of the US equity market over the past several weeks. It goes something like this, “If we can’t fall on tariff threats, Deepseek fears, the Fed pausing rate cuts; that’s incredibly bullish for the S&P 500, NASDAQ or whatever.”

I’ll admit – I’ve long used this whole “news versus price action” as part of my trading arsenal. But living and dying by this axiom alone can lead to disastrous results. In the case of tariffs, is it that we can’t fall on tariff fears or rather that the market doesn’t believe the tariff threats because of Trump’s history of quickly backtracking once he’s secured “an amazing deal!”? Just look at the situation with Canada and Mexico. The market quickly retreated on Trump’s announcement that tariffs would go into effect back on February 1. Two brief phone conversations later, those were pushed back at least 30 days. Those reciprocal tariffs President Trump promised as part of his “biggest announcement in history”? Those were also pushed back to April 2 and included very little detail in terms of rates, countries under consideration, on and on.

So, that’s the current set-up. Everyone, particularly the cheerleading permabulls, are busy celebrating every ALL-TIME HIGH. And while they’re busy only looking at “price”, it’s the conditions beneath the surface that has me particularly concerned.

Let’s get into the data. For starters, we can look at various measures of breadth. In the chart below, the lower pane shows the percentage of stocks in the S&P 500 above their 200-day moving average (red), the percentage of stocks in the S&P 500 above their 50-day moving average (black), and the percentage of stocks in the S&P 500 above their 20-day moving average (green). Each of these have their particular importance, but for the sake of clarity, the red line is generally a sign of long-term market breadth (supportive of longer-term trends), the black line represents intermediate-term health, while the green line is more of a short-term oscillator that follows the daily-to-weekly fluctuations in the market.

Source: Strom Capital Management LLC, TradingView

There are a few quick observations to make based off of this chart. First, the strongest forward returns for equity markets tend to follow periods where breadth is deeply oversold (below the 20% threshold in that lower pane). Second, during healthy bullish advances, you want to see that red squiggly line (Pct Above 200dma) holding near the 75% threshold. This is a sign of many stocks remaining within uptrends and thus a positive sign for broad market participation (2024 being a great example).

            Where concerns begin to mount is when we have falling participation. Many times, it may be difficult to spot this in real-time as these “breadth” lines tend to follow the oscillations of the broader market. However, it’s when we see divergences that warning signals should begin to pop up in our heads.

On the bullish side, we would want to see a given index hit new lows while breadth does not – you can see how in October 2023, the S&P 500 Index hit a new low, but the percentage of stocks above their 50-day moving average (black line) did not. This was a warning sign that the move lower was becoming exhausted and thus prone to a reversal.

Source: Strom Capital Management LLC, TradingView

On the bearish side, we look for the index hitting a new high, while breadth does not – the rally from mid-October 2024 to late-November 2024 being a recent example. This was a warning that the move higher was becoming exhausted and raised the possibility of a correction or, at the very least, a pause in the rally.

Source: Strom Capital Management LLC, TradingView

Today, here’s what we can see: 1) Only ~60% of stocks are above their 200dma (versus 75% at the December peak); 2) ~60% of stocks are above their 50dma (versus 70% at the late-November peak); and 3) ~55% of stocks are above their 20dma (versus 82% at the January peak). That’s what many will call a “negative breadth divergence.”

            Now, a breadth divergence by itself is never a reason to go long or short. But it’s when we factor in a number of other observations that I think the current environment gets particularly difficult.

            Here’s just a few observations…

1)      There is a negative divergence according to the Dow Theory. Basically, what the Dow Theory says is that, when you have a new high in the Industrial Average that is not confirmed by the Transportation Average (or vice-versa), it should serve as a warning for a potential market correction.

Source: Strom Capital Management LLC, TradingView

2)      There is a negative momentum divergence on both a daily basis, as well as a weekly basis. For this, we use the Relative Strength Index (RSI), which is a technical indicator that measures how fast and how much a security’s price changes. The thought amongst many technicians is that momentum tends to be an early warning sign for an impending change of direction. If the moves higher are taking longer and getting smaller (as with the current advance of eeking out minimal gains each day), that’s a “bearish divergence.”

Source: Strom Capital Management LLC, TradingView

3)      Homebuilding, Retail and Specialty Chemical stocks have been absolutely battered. Casual observation suggests that it’s a near daily occurrence that several stocks within these industries are experiencing significant downside volatility. Yesterday, we saw severe weakness in Toll Brothers (TOL), Louisiana-Pacific (LPX), and Wingstop (WING) following their respective earnings reports.

Source: Strom Capital Management LLC, TradingView

4)      The SKEW-to-VIX ratio has been hovering around levels, which suggests it’s a good time to be long downside volatility protection. The simplest explanation of the SKEW-to-VIX ratio is that it compares deep out-of-the-money options (SKEW = tail risk) versus closer at-the-money options (VIX = normal fluctuations). When this ratio becomes elevated, it’s generally a sign of one of two things – traders see brewing risk for a major event (rising demand for tail protection) or “normal fluctuations” i.e. the VIX is too subdued relative to the broader environment.

Source: Strom Capital Management LLC, TradingView

5)      Bank of America’s latest survey of institutional investors shows cash levels are at 15-year lows. According to BofA’s work, periods where cash levels dropped below 4% typically coincided with a temporary market peak. Furthermore, fears of a global recession are at a 3-year low as 36% of respondents see a ‘no-landing’ scenario, while only 6% predict a ‘hard landing’ (recession).

Source: BofA Global Research

Going back to that old trading axiom at the beginning, I mentioned the popular phrase we hear today, “If stocks can’t fall on tariffs, Deepseek, etc., then that must be incredibly bullish.” But remember, these anecdotal observations can work both ways.

What I don’t hear is the following, “If stocks can’t rally on the ‘most pro-business, pro-growth President in all of history’ (according to Bill Ackman and a few others), then…” I’ll leave you to fill in the blank.

That’s right – the S&P 500 Index has gone virtually nowhere since early-December. More troubling is the fact that the “most pro-growth President in all of history” has been met with increasingly negative performance from various cyclical industries that one would expect to benefit the most from major pro-growth policies (even Regional Banks boast a negative return since the market close on November 6, 2024).

As I said before, divergences should never be used in a vacuum to make a major directional call on any market. And, honestly, I don’t know if all these warning signs will result in something so sinister. But if we step back and weigh all of the evidence, here’s what we see…

1)      Valuations across a wide variety of metrics are the highest on record.

2)      Global investor allocations amongst the most bullish on record.

3)      Major technical warning signs from breadth, momentum and inter-market analysis.

4)      Caution flags are being waved from the volatility markets.

And that’s just the data. That’s not even factoring in the anecdotal observations of speculative activity in ‘meme stocks’ or ‘meme coins’, the Bank of Japan raising rates (historically, they tend to do so at exactly the wrong time), SoftBank piling in at what looks to be the potential top of a major bubble (look at their history with WeWork, aggressively trading options for the ‘gamma squeeze’ just before the Archegos implosion, Wirecard, etc.), cult stocks like Palantir (PLTR) trading at 80x forward revenue estimates, the fact that cutting all of this “wasteful government spending” might actually have a negative multiplier effect as it provides less capital to be spent into the economy, the list goes on and on.

I get it, being bearish doesn’t generally pay all that well and markets can “remain irrational longer than you can remain solvent”, according to John Maynard Keynes. But being cautious and being bearish are not necessarily the same thing. I do believe there are growing signs to be bearish, but at the very least, I think it’s a pretty good time to exercise a bit of caution.

A Shift in the Matrix

By Michael Coolbaugh, Chief Investment Officer

Note: The following comes from our daily research note published to clients on the morning of January 28, 2025. Given the raging debate, we’ve decided to make it public.

Whatever the media is trying to tell you, please do not believe that yesterday (January 27, 2025) was fearful or a sign of panic in any way. Per various trading desks, there was “strong cash buyers” immediately off the open. If we look at the ETF flows, we see the following…

SPDR S&P 500 Index ETF (SPY): +$6.1B; Invesco QQQ Trust (QQQ): +$4.3B (largest one-day flow since 2021); and Direxion Daily Semiconductor Bull 3x ETF (SOXL): +$1.3B.

This is not fear. In fact, it’s the farthest thing from fear. Every single Wall Street note that was published yesterday, except for maybe BMO’s piece on the “AI Power” theme, emphatically stated that the sell-off was overblown and that investors should be aggressively buying the dip. Read through the comments on Twitter (X) and you’ll see the same sentiment. People who have never heard of Jevons Paradox have suddenly become experts on the topic. For every one comment suggesting caution, there were at least ten saying this reaction is absurd and is a generational buying opportunity.

I am not an expert in Jevons Paradox, but here’s the short of it… It says that increased efficiency in resource use can lead to increased consumption of that resource. Basically, what people are saying is that because Deepseek proved to be far more efficient than OpenAI or other US models, it will naturally lead to a boom in demand for more semiconductor chips, AI data infrastructure, power, etc.

That certainly may be true. I mean, look at oil. There’s no question that cars have become much more fuel efficient but that hasn’t led to a collapse in the demand for oil. In fact, we use more oil now than ever. So, I’m certainly not one to argue that the same can’t be said for semiconductors.

What I am saying is that the breakneck speed with which AI infrastructure has been built – and the eye-watering amounts of CAPEX intentions from major Technology companies – might be overdone in the short-run. Remember, one of the promises of AI is that it rendered the cyclicality of semiconductors obsolete.

My point being, even with the ever-increasing demand for oil, that hasn’t canceled out the boom/bust cycle in oil. And the same can certainly be said for semiconductors.

You know, all of this reminds me of my former boss at PointState Capital. Back in 2014, he went on stage at the Ira Sohn Conference in New York City and presented a short thesis on oil.

At the time, oil was all the rage. WTI was trading around $100/bbl and investors were throwing endless amounts of money at E&Ps (exploration & production companies). It didn’t really matter the efficiency of each project or even the margins. All investors wanted to be told was that their money was being used to drill more because oil at $100/bbl meant GOBS OF MONEY for investors.

I actually love the slide that Zach used on stage – it was a clown car, with a bunch of clowns piled in and bursting out of every opening. Now think of that parallel to today’s environment. NVIDIA chips are insanely expensive. But the mad dash for AI supremacy has led to companies spending $60-, $70-, $80 billion per year in trying to reach the top.

To me, what Deepseek has shown is that those gargantuan figures of AI capex may not be necessary, even if it means more demand for chips in the long-run. What it could mean for the short- and intermediate-term is that AI infrastructure has been massively overbuilt because everyone accepted Sam Altman’s claims that all we needed was “more compute”. Remember, Altman is the one who claimed he needed to raise $5-$7 Trillion for increased chip-building (and let’s not forget that the last round of private financing for OpenAI included Nvidia as an investor…).

So, let’s say for just a moment that Deepseek’s claims are fabricated by just a tad. A lot of people are arguing that Deepseek is lying and, in fact, used ~$1-$2 billion worth of Nvidia chips. They also layer on top the few hundred million per year in operating expenses. Even if that is the case, even if it were $5 billion worth of Nvidia chips and $1 billion per year in operating expenses. What does that say for the major US Tech companies that are spending that PER WEEK?!?!

Just like everyone was caught up in the liquid gold rush back in 2014 and asking very few questions about the viability of projects, investors are doing the same today with the AI gold rush. And that’s why I think Semiconductor and these other AI Infrastructure plays are so vulnerable to a bursting bubble. It’s not that there won’t be demand for these things in the future. It’s that investors have extrapolated the never-ending good times for every single year into the future. Like Microsoft’s $80 billion and Meta’s $65-$75 billion in AI capex this year.

The trouble with these massively-inflated expectations is that any deceleration, or perception of deceleration, in demand can be catastrophic for careless investors. With oil, it was the massive drop in oil prices back in 2014 that exposed so many of the inefficient projects. With AI, maybe it’s the cost effectiveness and superior performance of Deepseek (which I’m sure US companies are trying to copy ideas from given it is ‘open source’) that reveals the inefficiencies once again.

At the very least, perhaps it serves as a wake-up call to all the sleepy investors who’ve been blindly throwing money at everything AI and causes them to start asking a few more questions about all those lofty promises.

With hype stories, it’s always about the sentiment. And thus far, there’s been nothing to disrupt the euphoria. But if you don’t believe me that the sentiment has clearly begun to shift, just look at comments from prominent Tech figures, like Marc Andreesen (Prominent Tech VC) or Marc Benioff (CEO of SalesForce).

Per Beniofff on Friday night, “Deepseek is now #1 on the AppStore, surpassing ChatGPT – no NVIDIA supercomputers or $100M needed. The real treasure of AI isn’t the UI or the model – they’ve become commodities…”

Per Marc Andreesen on Friday, as well: “Deepseek R1 is one of the most amazing and impressive breakthroughs I’ve ever seen – and as open source, a profound gift to the world.”

And Microsoft’s own Satya Nadella (emphasis my own): “To see the DeepSeek new model, it’s super impressive in terms of both how they have really efficiently done an open-source model that does inference-time compute and is super-compute efficient. We should take the developments out of China very, very seriously.”

Again, I ask; Have the vibes started to shift?

Momentum In A Mean Reverting World

By: Michael Coolbaugh, Chief Investment Officer

Last week, we shared our view that 2025 will be a year of mean reversion.

We probably should’ve been clearer about this stance as it’s primarily aimed at US equities. Valuations, sentiment, an off-the-cuff style administration, rates. You get the gist – there’s just an awful lot of crosswinds at play.

So, while buying dips and selling rips is likely a good approach for US equities here in 2025 (look no further than the first three weeks of January), I do want to expand a bit on a few possibilities.

As big fans of momentum, this naturally begs the question of, “Are you abandoning your strategy?”

The short answer is, No!

Let’s take a look at the US Dollar. If we go back to late September, there was a noticeable turn in betting odds for the presidential election. After trailing by a significant margin, various betting markets began to surge in favor of Donald Trump.

At the same time, the US Dollar Index (DXY) took off to the upside and hasn’t looked back since. Sure, the strength of the US economy versus rest-of-world (RoW) has played a part. But there’s no question that traders have been piling on to their bullish bets due to tariff expectations from the incoming administration.

We’ve witnessed the sensitivity of the dollar to the possibility of a less aggressive tariff policy on two occasions. First, when the Washington Post ran an article on January 6th, which Trump immediately refuted. And second, when Bloomberg ran a story on January 13th, suggesting tariffs could be implemented in a gradual progression.

Well, here’s where that theory of mean reversion comes into play.

If we look back at the 2016 election, the US Dollar exhibited similar behavior to what we see today. Following Trump’s victory, the US Dollar went on an incredible run, only to top out at the beginning of January 2017. Part of this was due to Trump’s interest in bolstering the competitiveness of US exports on the global stage.

Source: Strom Capital Management LLC, TradingView

For momentum traders, this is the danger. As early as January 2017, President-elect Trump blamed China for manipulating its currency to be weaker versus the dollar. Tweets were bountiful and on April 12, 2017, the Wall Street Journal ran a piece quoting President Trump as saying, “Dollar getting too strong.” He went on to say, “It’s very, very hard to compete when you have a strong dollar and other countries are devaluing their currency.”

Today, the US Dollar is as strong or stronger against most major currencies than it was at any point during Trump’s first term as President.

How long do we think it’ll be until the tweet storms start flying that the dollar is “too strong”? What if the worst-case scenario of 60% China tariffs on Day One is not realized and the news reports of gradual tariffs are indeed correct?

More importantly, how is the market positioned? Are they expecting a worst-case scenario? Even if that does come to fruition, how much fuel is left in the tank to propel things even higher?

Source: Kobeissi Letter, CFTC, Bloomberg

According to CFTC, hedge funds are the most bullish on the dollar since 2019 – right before it went on to lose ~10% over the course of 2020. Now, yes, one might look at this chart and say, “Hedge funds were extremely bullish in mid-2021 and they were proven correct!” That would be correct.

However, most of the bullish positioning was unwound by May of 2022, just before the DXY Index took off for a gain of a little over 11%. In fact, they piled back in right at the top in October of 2022.

But here’s where I think this set-up, plus our thoughts about mean reversion, are so relevant…

One school of thought is to sit back and say, “Play the mean reversion and short the dollar.” We’re not great mean reversion traders and, as I said at the outset, I’m not interested in abandoning my core strategy.

The other school of thought is to look for trades that might benefit from a dollar reversal but is still within our wheelhouse of trend and momentum trading.

That brings me to gold.

Over the past 4-5 months, gold has defied two of the primary drivers that have historically predicted its performance – real rates and the US Dollar. Generally speaking, whenever you see an asset defy historical logic, it should send up a warning flag. A flag that might be suggesting a major regime change.

Source: Strom Capital Management LLC, TradingView

What I like about gold is that it still fits within our methodology of trading in unison with long-term trends. It’s also an asset that has been consolidating for the past two months after an extremely strong run (consolidation is often a sign of disinterest as short-term traders become frustrated with the lack of progress).

Furthermore, much of the recent backup in “real rates” has been driven by an expansion in ‘term premium’. In other words, the rise in rates has not been driven by an increase in inflation expectations. This is another market narrative that the new Trump administration will continue to blow out fiscal deficits with numerous pro-growth policies.

As I sit here today, Scott Bessent, Trump’s nomination for Secretary of the Treasury, is sitting before Congress. And, in his own words, “The US does not have a revenue problem, we have a spending problem.” Does this sound like a financial expert keen on advising President Trump to blow out the deficit when we’re near peak employment?

Long-term rates have been surging due to this “fear factor” and, after two more benign inflation prints (PPI on January 14, 2025, and CPI on January 15, 2025), interest rates are violently reversing in the opposite direction. And, yes, throughout Mr. Bessent’s confirmation hearing, bonds have continued to rally (interest rates falling).

Rounding this all out, we have the following cocktail…

The dollar has been extremely strong for two primary reasons: higher US rates versus RoW and tariff fears. If we are entering a period of mean reversion (our theory for 2025) in both bonds and, by extension, the US Dollar, those are two headwinds for gold that may soon turn into massive tailwinds.

And, yes, we also have the possible “tweet effect” where President Trump might wake up one day and decide that the “dollar is too strong.”

Check Your Tool Kit

By: Michael Coolbaugh, Chief Investment Officer

If you’re wondering why we chose to kick off 2025 by digging into one of the less-exciting corners of the market, let me explain…

If you haven’t read the article yet, please check out Bob’s note on Broker-Dealers here.

So, why are we talking about Broker-Dealers in an environment flush with life-changing themes such as AI, Robotics, Quantum Computing, and any other shitcos the grifters can think up? Sorry, I let my cynicism get the better of me for a minute…

Well, it really goes back to studying what the last Trump presidency looked like. You see, leading up to the election, and immediately following Trump’s victory, everyone has been focused on “Trump Trades.” You know, the ones that are guaranteed to prosper under Trump 2.0. Long Energy, Banks, Industrials, Transports. Short China, Mexico, Biotech. Those sorts of things.

But what people aren’t talking about as much is the general environment for markets. Sure, I could go on and on about the record-high valuations, or the record-low allocations to cash, or even the eye-watering measures of sentiment by way of those who believe stocks will be higher in one year.

And sure, the natural first-order of thinking here is to parrot the “equities will struggle” catchphrase. That’s great and all, but how does that help in our approach to markets? How does it boil down to our trading and, ultimately, our odds for success in 2025?

The short answer is, it doesn’t.

Everyone looks back at the last Trump presidency and draws the conclusion that his time in office was uber-bullish for equity prices. After all, the S&P 500 Index closed 68% higher on January 19, 2021, than it did on January 19, 2017.

What also stands out is the fact that, under Trump’s first term, the S&P 500 Index registered one of the lowest readings for realized volatility on record in 2017. In that year, the S&P 500 Index generated the strongest risk-adjusted returns (highest Sharpe ratio) ever.

Source: Morningstar Direct

But what the revisionists don’t remember is the fact that Trump’s first term also brought a tremendous amount of volatility, as well.

We had the implosion of inverse volatility products (XIV) in early-2018. We had the Fed-induced meltdown in 2H 2018, which culminated in the ‘Christmas Eve Bloodbath’. There were also ongoing negotiations as part of the ‘China Trade Wars’, bringing plenty of back-and-forth action throughout most of 2019.

Of course, we can’t forget the scars from the Covid Crisis in early 2020, only to be followed by bouts of virus variants and fiscal uncertainty in the Fall of 2020, as well.

Source: Strom Capital Management LLC, TradingView

Before I continue, let me be clear, for all the murmurs coming from the back – I am not saying that Trump caused the XIV implosion, nor am I saying that he engineered the Fed’s ‘Christmas Eve Bloodbath’. And I’m certainly not claiming that Trump is to be blamed for Covid.

What I am saying is that investors – justified or not for their exuberant sentiment and positioning in risk assets at this point in time – need to be aware of their surroundings.

It wasn’t Trump that caused the disaster in short volatility. Rather, it was investors who had blindly positioned themselves for unending success after a record-setting run in 2017 (sound familiar?). It wasn’t Trump that caused Powell to state that the Fed’s balance sheet run-off was set to autopilot, despite the slowing of the economy, in the closing days of 2018.

If anything, it was Trump’s pro-cyclical fiscal policies that blinded the Fed into relentlessly tightening monetary policy. In other words, good for the economy but bad for asset prices.

Source: Strom Capital Management LLC, The Conference Board

China Trade Wars? Yep – Trump’s doing.

And we already touched on the exogenous nature of Covid.

The purpose of running through this history isn’t just to point out that valuations, interest rates, geopolitics, you name it, are all different than the set-up in January of 2017. In fact, we really didn’t touch on that at all.

No, the point of this whole thing is to suggest that traders may need to utilize a different skill from their tool kit in 2025.

Here at Strom, we’re big fans of momentum and expanding volatility. That’s how a lot of the old school macro guys made their fortunes. And, honestly, momentum in individual equities was a major winner in 2024.

That said, no strategy is perfect for all environments.

One thing we’ve been discussing internally is this idea that realized volatility will be much higher in the year ahead. Part of that is due to the challenging backdrop of valuations, sentiment and a difficult rate environment (real rates are still well into positive territory).

But, more importantly, it comes from the cognitive bias that we believe investors are suffering from today – rosy retrospection from Trump 1.0.

“Equities soared between 2017 and 2020 under President Trump.” 

“The first year of Trump’s presidency saw the S&P 500 register one of the best years in all of history!”

If an honest review of history tells us anything, it’s that a Trump presidency likely introduces a greater degree of volatility. Whether that’s his own doing or in reaction to his policies, we can’t ignore this reality.

I mean, just look at the past few days…

Monday, January 6, 2025: “Washington Post reports Trump aides eye narrower version of 2024 tariff pledges”.

20 minutes later: Trump on X: “The story in the Washington Post, quoting so-called anonymous sources, which don’t exist, incorrectly states that my tariff policy will be pared back. That is wrong…”

Wednesday, January 8, 2025: December FOMC Minutes: “Almost all participants judged that upside risks to the inflation outlook had increased,” the minutes said. “As reasons for this judgement, participants cited recent stronger-than-expected readings on inflation and the likely effects of potential changes in trade and immigration policy.”

So, as to that opening question about why we started 2025 looking into Broker-Dealers… Well, it’s one of many industries that have recently popped up as ‘oversold in an uptrend’ and, as Bob pointed out, has favorable fundamentals.

Obviously, just because something is oversold doesn’t mean it will be profitable in the future or that it can’t become more oversold. And, no, we never buy or sell something purely based off of fundamentals, either.

However, if we take a closer look at that first chart of the S&P 500 Index during Trump’s first term, one can see how, outside of a few brief periods, momentum really struggled.

Source: Strom Capital Management LLC, TradingView

So, as we settle into the New Year, let’s make sure that we check our tool kit. If momentum, in either direction, fails to materialize; just look back at this chart. If history is any guide, it might be wise to take a more contrarian approach (buy dips and sell rips) in 2025.

How Broker-Dealers Are Quietly Reshaping Wall Street

By: Bob Sheehan, Senior Research Analyst

While the world's attention has been captivated by the AI revolution and technology sector headlines, an equally compelling transformation has been unfolding more quietly on Wall Street. The broker-dealer sector's remarkable performance through 2023-24 tells a fascinating story of adaptation and evolution in modern finance.

Source: Strom Capital Management LLC, Yahoo Finance

What makes this story particularly intriguing is how these institutions have defied historical patterns during aggressive monetary tightening. Unlike previous cycles where such conditions strained financial intermediaries, today's broker-dealers have demonstrated unprecedented resilience. Their tier-1 capital ratios have remained remarkably stable even amid market turbulence, pointing to something more fundamental than mere survival.

The secret lies in the sector's profound transformation following the 2008 financial crisis. Rather than constraining operations as many feared, regulatory changes like the Volcker Rule modifications and Basel III implementation have paradoxically strengthened these institutions. Trading revenues have become more predictable, risk management more sophisticated, and capital allocation notably more efficient.

Source: Strom Capital Management LLC, Yahoo Finance

What's particularly telling is the quality of earnings we're seeing today. Operating margins have continued to expand even as interest rates peaked – a clear signal that we're witnessing structural improvements rather than just cyclical gains.

Source: FDIC

The sector's trading performance above key moving averages further reinforces this narrative.

Source: Strom Capital Management LLC, TradingView

Looking ahead, several key dynamics will shape the sector's trajectory. The Federal Reserve's potential policy pivot presents both opportunities and challenges, though historical data suggests broker-dealers often thrive during such transition periods. The implementation timeline of Basel III's endgame, evolving market-making capacity, and the continued rise of electronic trading platforms will all play crucial roles in shaping the competitive landscape.

We're also seeing interesting developments in industry structure, with potential consolidation among mid-tier players and growing divergence in technology investment strategies. The shift toward fee-based services represents another important evolution in revenue models.

Of course, prudent observers should keep watch on several risk factors. These include potential changes in fixed income trading volumes, the impact of artificial intelligence on traditional revenue streams, and evolving regulatory responses to market structure changes. Counter-party risk metrics in derivatives markets also warrant careful monitoring.

What we're witnessing appears to be the emergence of a new equilibrium in financial intermediation – one characterized by higher profitability and operational efficiency. However, this equilibrium is distinctly dynamic, requiring continuous monitoring of metrics like net interest margin sustainability, trading volume distribution, and technology investment ratios.

The transformation of broker-dealers represents more than just a successful adaptation to post-crisis regulations or changing market conditions. It signals a fundamental shift in how modern markets function and how financial intermediation is evolving. The implications for market structure, risk management, and capital formation are likely to resonate through the financial system for years to come.

Are We Headed Back to The Dark Ages???

By: Michael Coolbaugh, Chief Investment Officer

Many investors, myself included, have been sitting around and wondering what in the hell has been going on with cyclical/value stocks this December.

Most market participants look at the massive divergence between breadth (more stocks declining than rising in each of the past 11 trading sessions) and indices, which are hitting fresh all-time highs, and come away with a worrying message.

And for those who subscribe to the Stan Druckenmiller school of markets – we should be terrified of this message. Here’s what I mean…

Stan Druckenmiller is famous for watching the internals of the stock market to glean insights about the economy. A popular quote of his goes as follows, “The only good economist I have found is the stock market. To people who say it has predicted seven out of the last four recessions, or whatever, my response is that it’s still a lot better than any of the other economists I know.”

What he means by this is that the performance of stocks within certain sectors or industries tends to give a reliable lead on future economic activity.

 So, let me paint you a picture.

Sources: TradingView, Game of Trades

 The thing is, conventional wisdom says that whenever the 10-year/3-month yield curve dis-inverts, it typically means a recession is right around the corner. In fact, it’s the only indicator that has a 100% success rate with calling recessions.

What just happened? The 10-year/3-month curve dis-inverted on December 9, 2024.

Let me add a bit more color… ‘Value’ stocks have recently traded lower for a record-setting 11 consecutive days – something Stan fans would say is a worrying sign of things to come.

But wait, there’s more – a whole lot more…

I’m about to run through a series of graphics to give a better sense of the current set-up for equity markets.

On November 4, 2024, Bloomberg made the brilliant observation that “Unbeatable US Stocks Leave Diversifiers in the Dust.” In its article, the columnists went on to pose the question, “Why Not Invest 100% in Stocks?”

Not typically something you hear at the start of a major bull market…

Around the same time, a popular research provider named SentimenTrader published a study to demonstrate the insane flows into levered bullish products.

Source: SentimenTrader

Again, not something you see at the start of a major bull market…

The Economist, not to be outdone on the Stupidity Meter by any publication, followed this up with their own story which read, Should Investors Just Give Up on Stocks Outside America?

Source: The Economist

We have the likes of Walmart (WMT), you know, the boring old consumer staple company selling everyday basic goods, trading at 40x earnings. Costco (COST), the bulk provider of similar products trading at 58x earnings.

I mean, did these big box stores suddenly discover some new weight loss pill that dwarfs the efficacy of Ozempic?!

Now, you’re starting to see why The Economist question registers so high on the Stupidity Meter…

Apple Inc (AAPL) is trading at 10x sales. Paging Scott McNealy (CEO of Sun Microsystems) from the Dot Com era…

“At 10 times revenues, to give you a 10-year payback, I have to pay you 100% of revenues for 10 straight years in dividends. That assumes I can get that by my shareholders. That assumes I have zero cost of goods sold, which is very hard for a computer company. That assumes zero expenses, which is really hard with 39,000 employees. That assumes I pay no taxes, which is very hard. And that assumes you pay no taxes on your dividends, which is kind of illegal. And that assumes with zero R&D for the next 10 years, I can maintain the current revenue run rate. Now, having done that, would any of you like to buy my stock at $64? Do you realize how ridiculous those basic assumptions are? You don’t need any transparency. You don’t need any footnotes. What were you thinking?”

For the S&P 500 Index, as a whole, we are now trading at a higher price-to-book multiple than the peak of the Dot Com bubble.

Don’t like price-to-book? Fine. The S&P 500 Index now trades at a price-to-sales multiple that is ~35% higher than the peak of the Dot Com bubble.

Source: Bloomberg

Michael Saylor, yes, the one who was charged by the SEC in March of 2000 for fraudulent reporting of financial results, has apparently invented an ‘infinite money glitch.’

In fact, some point to Saylor being charged as one of the lynchpins to the bursting of the Dot Com bubble. Wouldn’t that be something if he managed to do it again with the addition of his company MicroStrategy (MSTR) to the NASDAQ 100 here in December 2024?

I mean, what could go wrong with this strategy? Sell debt and stock, buy bitcoin with the proceeds, price of bitcoin goes up so stock price goes up, sell more stock and debt, buy more bitcoin with new proceeds, price of bitcoin goes up more, stock price goes up more, and on and on and on.

See? I told you it was an infinite money glitch!!!

The meme cryptocurrency Fartcoin – closing in on $1 billion – now has a market cap larger than the vast majority of publicly-listed US stocks.

Permabears David Rosenberg, Mike Wilson and Nassim Taleb have all thrown in the towel as they concede that there’s no stopping this bull run.

‘Quantum Computing’ headlines are dominating the air waves as stocks with $37 million in revenue, -$172illion in net losses, and -$114 million in operating cash flows are trading for >$9 billion in market cap.

Do you know when we hear of ‘quantum computing’ breakthroughs? I’ll give you a hint…

“Scientists make seven-bit quantum leap in computer research” – March 29, 2000

“Multiverse Computing Partners with IonQ to Bring Quantum Computing to Global Finance” – November 11, 2021

“IBM Unveils ‘Eagle’ Quantum Computer Processors” – November 16, 2021

“Google Says Its Quantum Chip May Prove Parallel Universes Exist” – 12/11/2024

Do any of these dates ring a bell? Were they not when equity valuations were at their absolute peaks in all of history? Were they not at a time when hype after hype was being sold to gullible “investors”?

I mean, seriously, Google is proving that parallel universes exist?! They’re not even pretending to respect our intellectual capabilities anymore…

BlackRock has proclaimed that the Boom & Bust cycle of the economy no longer exists. Calling Irving Fisher – “Stock prices have reached what looks like a permanently high plateau” – just nine days before the Wall Street Crash of 1929.

Meanwhile, corporate insiders and Warren Buffett both seem to see the writing on the wall. Buffett now holds ~28% of its total value in cash – its highest level since at least 1990.

The Corporate Insider Ratio of Sellers to Buyers has also hit a fresh all-time high…

Source: Financial Times

Granted, neither one of these tend to time the market with any sort of short-term precision, but it should serve as a warning nonetheless.

On the flipside of these, let’s just call “rational actors”, we have the psychos running the asylum.

Equity allocations have surged to the highest on record…

Cash allocations have fallen to the lowest on record…

Everyone wants equities and Bitcoin, while no one wants cash or bonds…

And when I say everyone, I don’t just mean “Fund Managers” from the Bank of America survey…

Consumers are now the most bullish on record and by a wide margin…

Source: Bianco Research

Asset managers are running close to an all-time record high in long exposure to S&P 500 Index futures (just below the January 2020 peak).

Any way you slice it, this market is down-right euphoric. Manic. Crazed. Greedy. Reckless. Absurd. Stupid. I honestly can’t think of enough adjectives to describe what we’re seeing in today’s market.

And this is only a sliver of the evidence – both statistical and anecdotal – that points to the level of stupidity we’ve reached today.

So, let me tie all this back into my original question of, “Are we headed back to the Dark Ages?”

If things were so amazing, why have ‘value’ stocks fallen for 11 consecutive trading days? Note – at the time of this writing on December 17, 2024, we’re on pace to make it a 12th consecutive day. Are the internals of the stock market telling us that Warren Buffett and all those corporate insiders might be onto something?

My gut tells me, yes. And all that I’ve laid out above is plenty enough for people to be extremely cautious as we head into 2025. But let me pose one other theory as to what might be driving such a dramatic divergence – one that might not set off the alarm bells…

Source: Strom Capital Management LLC, TradingView

Here’s a 10-minute chart of the iShares S&P 500 Value ETF (IVE) in red, compared to mega cap Tech stocks such as Alphabet (GOOG) in black, Tesla Inc. (TSLA) in light purple, Apple Inc. (AAPL) in dark purple, and Amazon.com, Inc. (AMZN) in green.

Notice anything about the start of December when all of those colored lines really began to generate strong upside momentum? What happened to value (red line)? It started to drop. The action wasn’t panicky, just a steady bleed lower, almost as if some major institutions were running large ‘sell programs’ to get out of value stocks. The same can be said for the steady grind higher in those Tech names.

What makes this even more bizarre is the backup in interest rates over this same time period as value and rates tend to be positively correlated (rising rates tend to indicate stronger expectations for economic growth and thus value stocks perform well).

Why is this happening?

Leading up to and immediately after the election, investors loaded up on banks, industrials, materials, energy, transports – the classic “Trump Trade 2.0”.

After the election, this worked for a few days. However, once we turned to December and those major Tech names (not in the Trump Trade 2.0 playbook) started to generate upside momentum, year-end performance chasing went into full effect.

Year-end bonuses, performance reviews, client conversations, you name it, are all based on how you performed versus the market. How could you, as a portfolio manager, be overweight equities but still lag so far behind the market as it melts higher?

Now, we just went through an entire backstory of how investors hold virtually no cash. So, in order to get cash to chase the accelerating momentum, investors have been forced to dump what they were previously overweight (banks, industrials, transports, materials, etc.). And, yes, this could also be why bonds have not been able to find any bid despite the supposed deterioration in market internals.

Are we headed back to the Dark Ages? I mean, come on, don’t be ridiculous. There are plenty of reasons to be extremely cautious of the current market, none better than the simple fact that there appears to be no fear at all.

The pitiful nature of the 2022 “bear market”, and its subsequent rebound back to euphoric levels, has most investors believing that invincibility is an actual thing.

My point in this whole discussion was merely to lay out that, yes, weak forward returns for the equity market seems probable. But the belief that a crash is imminent, based off the recent weakness in ‘value’ stocks, might be a bit premature. Year-end flows always play a major part in the performance of various asset classes (tax loss, deferring cap gains, performance chasing, etc.).

What can we do? De-risking is naturally one option. But positioning for a corrective rotation isn’t the worst of ideas, either. Maybe that comes after December OPEX (December 20, 2024). Or perhaps it isn’t until January of 2025.

All I know is that we either see a significant rotation in short order or perhaps it is time to start running for the hills…

Through The AI Noise…

(Originally posted March 11, 2024)

Let me start off by stating a few things, with perfect clarity, to ensure that there are no misconceptions about my views.

First, and unfortunately, we must lay out that this is in no way investment advice. This is merely my own view of today’s circumstances, how I think things will play out, and which ways I’m inclined to play these views. As with anything, everyone must do their own research and evaluate what is best for them and their financial situation.

Second, this is not an opinion about the so-called “AI Revolution.” Even me calling it “so-called” is not intended to throw shade at the growing developments we’ve seen out of this technology. In fact, what I’m about to write has absolutely nothing to do with either a positive or a negative outlook on Artificial Intelligence. This is not a bullish AI article nor is it a bearish AI article.

Third, I’m a macro trader whose positions are typically held anywhere from a couple of weeks to three-to-six months. I’m also not a long-term fundamental investor, which means I change my mind A LOT.

Lastly, I understand that whenever we talk about the market or specific investments, many participants adopt a tribal nature. You’re either full-blown bullish or miserably bearish – there’s no in-between. I appreciate that there are people who know far more than I do about the topics with which I’m about to cover and am always happy to hear constructive feedback.

Ok, so now that we have a few disclaimers out of the way, I think it’s about time we get down to what the heck it is I wanted to write about. See, for me, writing is a therapeutic exercise. Aside from my duties as Chief Investment Officer at Strom Capital Management LLC, I write a daily research note through another company I founded back in 2019.

The reason I started that research service is entirely different from why I continue with it today. Back in 2019, I was seeking to share my views of the world. I didn’t have your prototypical background of spinning out of a large hedge fund where investors were lining up to hand me nine-figures to manage. I was trying to get my voice out there and make a name for myself.

But today, I am lucky enough to run my own hedge fund and the research has taken on a different purpose. I enjoy writing. It helps me organize my thoughts, which is often a difficult thing to do in this crazy world of information overload. I do write to keep my investors informed of how I’m thinking about the world. But I also do it because it serves as a gut-check on my portfolio. If what I’m writing contradicts my portfolio, then something is clearly off.

Sometimes, I don’t even know what I’m thinking and feel completely out-of-tune with the market. I can’t figure out why this or that is happening. I don’t understand what investors are seeing that makes them tilt one way or another. Or sometimes, it’s just that the economic data and market action is so conflicting that I don’t feel comfortable taking a strong stance.

So, here we are in mid-March of 2024 and I’m watching Semiconductor stocks rally anywhere from 4% to 15% every day. And while I do appreciate a great momentum story, I simply can’t bring myself to buy something with so much hype behind it and so far from any realm of rationality based on any number of technical indicators. Please note – I’m not even bringing up fundamentals here because I’m not a sector specialist and, as I said at the beginning, this is not an argument for or against the legitimacy of AI-driven demand.

That’s why I sat down to write this today. I admit, I’ve been on the sidelines of this parabolic move in AI, particularly Semiconductors. With momentum as part of my process, I even bought the initial breakouts in names like NVIDIA Corp (NVDA) and Super Micro Computer (SMCI) at the beginning of 2024. But I admit, I didn’t fully understand it and the moment things felt a little silly to me, I bailed. That was in late-January of 2024. Yeah, talk about a serious face-palm moment.

So, instead of making some hasty decision to go long or, please hold the gasps, dare to go short, I figured I’d try to organize my thoughts and let it all spill out onto paper (well, virtual paper in Microsoft Word).

But before we get into the nitty gritty, I’d like to share some details about my overall macro view. Going back to early-November of 2023, I adopted a risk-on view for equity markets. This was a shift for me because I had been relatively cautious since the summer of 2023 and actually made some pretty decent money being short things outside of the United States. Yes, while the Tech rally was in full effect throughout all of 2023, there were growing signs that the rest of the world was slowing dramatically, and many foreign equities were confirming that narrative. We even saw leading indicators here in the United States roll over into strong contractionary levels.

For me, one of my rules to market cycles has always been to watch foreign equities, especially those ETFs that do not hedge currency exposure. The reason being, a stronger US Dollar tends to weigh on the rest of the world and any weakness should be manifested through poor performance of those assets.

We’ve seen this throughout numerous cycles since the Global Financial Crisis (GFC). Late-2014 and all of 2015, foreign ETFs lead with a strong bearish trend. Eventually, the US market followed with some turbulence in late-2015/early-2016. Then the rebound in early-2016 as China unleashed its massive fiscal stimulus. Again, foreign ETFs flipped bullish and rallied hard until early-2018. That was followed by another rollover into a strong bearish trend in mid-2018 and, of course, resumed its bearish tendency just prior to the carnage from the Covid Crisis.

Flip around, we saw a strong rally back in late-2020 as all that pent-up fiscal stimulus juiced the economic cycle. And then we saw a dramatic rollover in Q4 of 2021, just before the US equity market hit the skids with its 2022 “bear market.”

Well, between August and September of 2023, we saw another bearish flip from a long list of foreign equities. I had been short, covered the October lows, and was looking to get short again on a technical relief rally. After all, foreign assets were still within a strong bearish trend and leading indicators were screaming “GLOBAL RECESSION.”

Then it all changed. That relief rally quickly turned into a bullish trend flip for foreign assets. We saw decelerating rates of inflation from all around the globe. And investors were eager to embrace the idea that the Federal Reserve would soon be cutting interest rates. Oh, and not to mention, the strong seasonal tendency of markets to rally over the final months of a strong year.

I was bullish and I really liked many of the beaten-down areas of the market (dynamics of tax-loss selling and a new calendar year). If inflation was easing and the market loved the idea of rate cuts, then all those areas that had been panic-sold might experience a strong rebound.

But then I got to thinking, maybe the collapse in leading indicators was more a factor of an inventory correction cycle, as opposed to a full-blown recession. After all, companies spent the tail end of 2022, and most of 2023, dealing with excess inventories that were purchased in fear of the same supply-chain constraints that wreaked havoc during Covid. Company after company echoed the excess inventory story and, as we worked through those, manufacturing and production contracted.

If we go back to November of 2023, it wasn’t just that the market action was telling me something was wrong with a bearish view of the world. It was also that we started to see hints of a trough in the same leading indicators that confirmed the bearish market trends since late-2021. Again, this is speaking to trends in foreign assets and cyclical equities, not the Magnificent 7 (“Mag7”) Tech rally of 2023.

I’ll admit, I struggle with ‘growth’ investing and 2022 was just another example of the dangers in participating in something you know nothing about. I avoided ‘Growth’ and Tech in 2022 but I also didn’t play its rebound in 2023.

And, yes, this was probably a strong reason why I was too jumpy to stick with the Semiconductor and Technology trades in early-2024.

Instead, I believed there was far more opportunity in the beaten-down areas of the market. The same cyclical and foreign assets that experienced the painful manufacturing/production recession of 2023. I thought to myself, “If this inventory correction is a mid-cycle trough, then cyclical assets are probably far too cheap as everyone was convinced of an imminent recession.”

So, that’s what I played. Building Materials, Metals & Mining, Specialty Chemicals, Transportation, Machinery, and even some Financials.

And then I dug some more. The Inflation Reduction Act, the Chips Act, fiscal stimulus was still booming. In fact, what many didn’t realize is that those bills that were passed in 2022 actually had barely begun disbursing the funds.

I thought some more…

If there’s one thing that came out of Covid – I know there were many – it’s probably that supply-chains had become far too globalized. Of course, the Russia/Ukraine War reinforced this idea for Europeans. Well, ever since the global pandemic, the United States, and many other countries around the world, placed an emphasis on “re-shoring.”

I’m going off of memory here, so it’s probably not perfect, but for a while there, it felt like we had some major announcement of a new Semiconductor plant being built in the United States almost every month. Intel, Taiwan Semiconductor, Micron. It was like a CAPEX dream. And, yes, further evidence of the power behind all that fiscal stimulus.

I thought, “Perfect! If all these plants are being built in the US, they’ll need materials! If infrastructure is being repaired, they’ll need materials! If housing is still in short supply, they’ll need to build more. More materials!” So, I upped my exposure to those industries mentioned above.

Turning the page now to early-February 2024 and it hit me. Growth is resilient. The rate of inflation is easing towards the Fed’s goal (there have been hiccups along the way, but the larger trend is still intact). But more importantly, we can see increased signs of a rebound in those leading indicators. Maybe this was just a mid-cycle trough after all!

And that’s when things got a bit silly. As I sat back in my chair, I texted a former colleague and friend. Here’s what I wrote on February 14, 2024…

“Serious question… Are we thinking about this all wrong?

The Fed clearly wants to cut rates this year. Goolsbee said today that they don’t necessarily want or need to wait until we hit 2% exactly. In what world is this not ludicrous that the Fed is no longer acting in a counter-cyclical fashion and actually cutting rates in the face of a strong economy?!?!

The Fed is meant to smooth the business cycle, but today they’re actually talking about juicing the cycle.

Everyone, myself included, laments how the market is ridiculous in getting excited for potential rate cuts. But, in the grand scheme of things – how could it not be wildly bullish for equity prices if you have a strong economy AND monetary easing?!

Historically, and this is what Druckenmiller and PTJ always talked about, a strong economy tends to precede a weak period for equities because it means the Fed will be raising rates/withdrawing liquidity in a counter-cyclical fashion. We’re actually talking about doing the exact opposite…”

I upped my exposure some more…

So, now I sit here in mid-March, and I watch with frustration as Semiconductors continue to rally 5%+ every single day, while cyclical equities rally at the open and get sold off throughout the day.

I don’t know, maybe investors see interest rates falling and they think, “Must be a recession, so sell cyclicals.” Only thing is – Semiconductors are cyclical too, but that’s gone out the window because everyone dares to utter Sir John Templeton’s four most dangerous words in investing, “This time is different.”

Personally, I’m not one to say, “The market is wrong, I know more.” I listen to the market, its internals, and try to decipher the message. But to me, I think this “pop and fade” action in cyclicals is due to some investors reacting to falling yields (“Recession”), while others pull capital from every other area to pile into the momentum chase in Semiconductors.

In the grand scheme of things, the action beneath the surface of the market, especially with respect to cyclicals, is actually very bullish. Despite this “pop and fade” behavior, trends are broadly turning higher, and from very depressed levels. More importantly, flows show little-to-no signs of euphoria for these corners of the market.

So, what do I do? Do I capitulate and chase the Semiconductors? Believe me, it’s entered my mind more than once. But then I remembered an interview that Stan Druckenmiller gave about his experience with the Dot Com Bubble.

Here’s a snippet from an article on The Irrelevant Investor…

When asked about his experience, Druckenmiller said “I bought $6 billion worth of tech stocks, and in six weeks I had lost $3 billion in that one play. You asked me what I learned. I didn’t learn anything. I already knew that I wasn’t supposed to do that. I was just an emotional basket case, and I couldn’t help myself. So maybe I learned not to do it again, but I already knew that.”

The reason I bring this up is because today, we see any number of analogies to bubble periods being thrown around. “Breadth is its narrowest since 1929.” “The ratio of Semiconductors-to-S&P 500 Index just surpassed the Dot Com bubble peak.” “The top 10 stocks in the index exceeds the level of concentration seen during the Dot Com bubble.”

Look, I have no idea if we’re at the start, in the middle, or reaching the end of a bubble. But as I said before, given the overall conditions being presented to us, it’s hard not to appreciate the reality that policy makers are encouraging a bubble.

And in that spirit, here’s the full text of what I wrote in my morning note on March 8, 2024…

Ok, yesterday was short and sweet, but today, I have a few things to get off my chest. For beginners, we have Non-Farm Payrolls at 8:30am, so that’ll be the trigger that sets the tone for today’s session. That’s the short of it. But the more nuanced version comes from what we heard yesterday from both Jerome Powell and President Joe Biden.

I have to admit – I was in and out of paying attention to Powell’s testimony because there was some truly bizarre stuff going on. I mean, Senator Kennedy’s line of questioning was out of this world and, for anyone watching these Q&A sessions, it really makes one question what sort of banana republic our country has become.

But speaking of that banana republic, what I found most interesting with Powell’s testimony yesterday wasn’t these out-of-this-orbit questions. It was actually Powell’s certainty – without using the word certainty – that the Fed is close to cutting interest rates. I mean, this is a Fed that repeatedly hammers away at these ideas of “independence” and “data dependent.” Now, if the Fed was truly data dependent, why in the world would Powell state that, “… we are very close to gaining enough confidence to cut interest rates.”? Is that not him basically saying, “Data be damned, we’re going to cut rates!”?

The reason I ask this is because there are a number of inflation indicators that have witnessed a decent bounce lately. Sure, they’re all within a larger downtrend, but January’s data was pretty strong and should give anyone a bit of pause. Fed’s Mester made her own speech yesterday and even she said that the January report was “a bit of an eye opener.”

And then there were the numerous questions lobbed towards Powell about issues with the housing market. Affordability, lack of entry-level options, etc.  He was probably asked at least 20x about issues with the housing market. His response? It’s a structural supply issue. It’s about the “locked in” effects of low fixed rates during the pandemic (people bought at very low rates, so they’re not selling now because they don’t want to lose those rates when buying a new home). It’s zoning and supply-chain constraints. In other words, it’s not the Fed Funds Rate, it’s not the pace of QT that could be adjusted to manipulate the long end of the curve. Simply put – it’s not a demand issue, it’s supply, and thus we basically have to deal with it and build more.

Then there was his response to fiscal deficits. In his own words, “we are nowhere close to the point where fiscal policy dominates monetary policy.” Umm, maybe we’re all living in a different world, but does anyone else question this, given what we’ve seen with economic activity in the face of the most aggressive rate-hiking cycle in decades?

What I came away with Powell’s time with Congress is that they don’t really care about deficits. They also don’t care about housing affordability. And he undeniably stated that the Fed will not wait until inflation hits 2% exactly to cut rates.

Again, I ask, is the Fed really data dependent?

Then there was a subtle, but really telling, development from Lael Brainard, Director of the National Economic Council. According to multiple reports, Brainard pushed to change Biden’s budget forecast by assuming lower interest rates in the future, which paints a rosier picture of borrowing costs at a time of surging deficits and government debt issuance. The interesting part here is that Bloomberg reports that the Director of the NEC is typically not involved in setting these forecasts – those are set by the Treasury Secretary, OMB Director, and Chair of the Council of Economic Advisers. Hmmm…

The reason I find this so interesting is because it was reported on numerous occasions that Lael Brainard (former Fed Governor) was very close to being chosen as a replacement to Jerome Powell as the Chair of the Federal Reserve. For whatever reason, Biden elected to stick with Powell this latest go-round. But at a time when politicians continually press the Fed to lower interest rates; should we be surprised if Brainard is tagged as the next Fed Chair in 2026?

Again, I ask, is the Fed really independent?

Ah, ok, now on to the State of the Union and Biden’s remarks that tie in so nicely with these gems from Powell and Brainard. As Biden proclaimed, “Mortgage rates will be coming down and the Fed acknowledges that.” After a lengthy two days of questioning Powell about housing issues, Biden’s solution is two-fold: a $400/month tax credit over two years for buying a home and a $400/month tax credit over two years for homeowners selling their first home (presumably to encourage people to shed those low fixed-rate mortgages and move up).

Going back to my point about Powell – it’s all about structural supply issues. So, instead of incentivizing the building of more homes, we’re simply going to subsidize demand. Where will that come from? More deficit spending. Do we really think that will fix pricing issues? Do we really think that’ll detract from inflation? We’re not trying to lower housing prices; we’re merely doling out more cash to justify and contribute to those elevated prices.

Alright, alright, I’ve ranted for long enough. As I’ve been saying all along, there’s really no use in complaining about what’s going on. There’s also no use in trying to exercise your intellectual superiority by arguing what the Fed should do. All we need to do is sit back and observe what the Fed is doing. And our politicians.

What we’ve just heard from Fed leadership, arguably the next Fed leadership, and our politicians, is that things are full steam ahead with juicing an already strong economy. We’re going to pour gasoline on the fire that is a cyclical upswing. One that’s already being driven by, you guessed it, more fiscal spending!

What does this imply for our investments? Well, it’s not that Tech, Semis, whatever won’t keep working. I mean, if we’re dead set on blowing a massive asset bubble, why stand in the way of it? But what I continue to hammer away at is, if we are truly going to further subsidize demand – whether that’s through lower rates or direct cash handouts – it’ll become increasingly difficult to return inflation to target. And in that sort of an environment, especially with the Fed blessing it, cyclical equities and commodities look extremely attractive.

Furthermore, it likely implies that bonds won’t give you a whole lot in your portfolio. Sure, you’ll get a nice nominal yield here. But when accounting for inflation, it certainly won’t be anything to write home about. It also limits my outlook for any meaningful capital gains (price appreciation) for long-term bonds. I mean, as it stands, there’s already zero term premium built into the curve, so why own anything far out on the curve if we’re turning on the afterburners of this economy?

I said this a couple of weeks ago, but sounding so bullish truly makes me feel uncomfortable. I came into my professional career in the immediate aftermath of the Global Financial Crisis (I was interning during the GFC). I’ve traded during China’s shock devaluation, the volatility shock of 2018, the Christmas Eve Bloodbath of 2018, the Repo Crisis of 2019, the Covid Crisis of 2020, and the ensuing madness of 2020/2021 before a brutal deflation of that bubble. Skepticism has been ingrained in me since the start, and it’s a bias I need to remind myself of on a daily basis.

But if I step back and am completely honest with myself about not what I think is right/wrong or what policy makers should do, I firmly believe we’re headed full steam ahead into another massive bubble. There’ll be a time when things correct, or the bill for all these reckless policies comes due, but that likely won’t happen until we’ve realized what an epic mistake we’ve made. So, again, as uneasy as it makes me feel, the best thing we can do is abide by what we see happening. And until that changes, I think it’s a dangerous game to go fighting this market simply because “it’s silly, it doesn’t make sense, or it’ll all end in tears.”

That’s my current view of the world, but for anyone who’s known me for more than a couple of weeks, I change my mind A LOT. I might feel a lot differently about an ultra-bullish stance in a week, two weeks, a month, a quarter. Who knows? But as things are, that’s where I stand.

Ok, ok, so why in the world did I mention AI and provide those disclaimers at the outset?

Up until now, everything has been about setting the stage. The stage where there’s rampant euphoria around AI and Semiconductors. A stage where there’s complete panic about increasing the supply of semiconductors because the demand forecasts are actually hitting the moon. But it was also meant to provide a little context that you’re not just reading from some grumpy old perma-bear.

If you haven’t gathered by now, I idolize Stan Druckenmiller. A lot of how I look at the world and how I approach markets is very similar to Stan. Not because I want to be Stan, but because whenever I hear him talk, whenever I read about his philosophy, it fits with my own personality. That’s the most important thing we can do as investors or traders. It’s ok to borrow things from other extremely successful investors. But we’re all our own individuals with our own personality flaws. We all need to adopt our own approach.

Well, to channel Stan one last time, I’d like to share another one of his quotes.

“Chemical stocks, however, behave quite differently. In this industry, the key factor seems to be capacity. The ideal time to buy the chemical stocks is after a lot of capacity has left the industry and there’s a catalyst that you believe will trigger an increase in demand. Conversely, the ideal time to sell these stocks is when there are a lot of announcements for new plants, not when the earnings turn down. The reason for this behavioral pattern is that expansion plans mean that earnings will go down in two to three years, and the stock market tends to anticipate such developments.”

This rhymes so perfectly with what I’ve learned from other portfolio managers throughout my career. Broadly speaking, cyclical stocks are a bit counterintuitive because you want to be buying them when their valuation multiples are high (weak earnings) and selling them when valuations look cheap (strong earnings).

I previously mentioned Specialty Chemicals as one of the industries I find attractive and, it just so happens, their valuations look insanely expensive right now.

Better yet, does anyone remember all throughout the post-Covid recovery and the Russia/Ukraine War when we heard of plants being shut down due to the energy crisis? Anyone remember the inventory/production correction from 2022/2023?

That’s capacity leaving the industry. That’s when earnings collapse and stocks look insanely expensive on a price-to-earnings or enterprise value-to-EBITDA multiple.

But do you also know what’s required for all those building materials that are in such strong demand as new plants are being built here in the US? Or what goes into asphalt, concrete and other materials needed to repair and upgrade our infrastructure? Among other things like copper, lumber and steel, Specialty Chemicals.

Here’s just one quick example of a name within this industry – Huntsman Corporation (HUN).

Huntsman currently trades at a P/E multiple of 50.9x and an EV-to-EBITDA multiple of 15.3x. It traded at a peak P/E multiple of 53.8x in Q3 of 2023, right around where the stock appears to have troughed. You know where valuations stood at its stock price peak back in early-2022? A P/E of 4.9x and an EV-to-EBITDA multiple of 5x. The stock went on to fall ~45% since the valuations looked “cheap.”

I know, sounds crazy, but it’s true…

Do you also know that specialty chemicals are needed in the production of semiconductors?

Hmm, to me, this sounds like an industry that looks extremely unattractive (investors quiver at the multiples), capacity has been withdrawn, and there’s multiple catalysts to increase demand. All that we’ve discussed doesn’t even include Electric Vehicles or the push for renewable energy.

Let’s flip this whole argument on its head and ask, “What industry is seeing a lot of announcements for new plants?”. Dare we mention Semiconductors? According to Z2Data, there are a total of 73 new semiconductor fabs being built around the world. Here’s a list of just a few…

1)      Foxconn – India, 2025

2)      Foxconn – Malaysia, 2025

3)      Guangzhou CanSemi – China, 2025

4)      Hua Hong Semiconductor – China, 2026

5)      Nanya Technology – Taiwan, 2025

6)      Powerchip Semiconductor Manufacturing – Taiwan, 2023

7)      Samsung – South Korea, 2023

8)      Semiconductor Manufacturing – China, 2024

9)      Semiconductor Manufacturing – China, 2025

10)  Taiwan Semiconductor – United States, 2024

11)  Taiwan Semiconductor – Japan, 2024

12)  Tower Semiconductor – India, 2028

13)  Micron – United States, 2025

14)  Intel – United States, 2024

15)  Samsung – United States, 2024

16)  Texas Instruments – United States, 2026

Now, the thing to remember with this are the trade restrictions the United States is placing around China due to national security concerns. In other words, that’s a massive detractor from demand (China is attempting to furiously build its own supply), while supply is projected to explode.

Here’s a breakdown of planned projects just here in the United States, according to Industrial Info Resources.

Link to article

I’m always the first to admit that there are plenty of people out there who are far smarter than me about their respective industries. I’m not a sector specialist and I’m certainly not a deep-in-the-weeds fundamental investor.

Maybe demand will still outstrip supply. Perhaps the AI revolution is only in its infancy, and we can’t even fathom the true level of demand for semiconductors. I honestly have no idea and, if we’re honest with ourselves, even the “expert” analysts at banks can’t make accurate 10-year predictions either.

And that’s why I won’t even bother to make any sort of statement about whether or not the current activity in Semiconductor stocks qualifies as a bubble. Maybe it is. But maybe it’s not.

This is just me, sharing what I’ve learned over the years, and hopefully making some very clear and unemotional observations about how market cycles tend to work.

What does this all mean?

If I were a betting man, and I guess I sort of am considering I run a hedge fund for a living, I’d have to place better odds on something like beaten-down Specialty Chemical stocks outperforming Semiconductors over the coming 12-18 months.

Why 12-18 months? That’s typically the window with which markets tend to discount the future, at least according to academic research.

And over the next 12-18 months, we can see one industry has already had capacity withdrawn with very clear tailwinds to boost demand (infrastructure, housing, new plants, semiconductors). The other has massive capacity being built with wild imaginations of persistently growing demand (right or wrong, it creates a high bar to clear).

Again, this isn’t a call to rush out and short Semiconductor stocks. I’m certainly not doing that, given my overall macro view at the moment. And who knows if I ever will – a correction phase could be dramatic and steep (bubble collapse) or a boring old sideways grind while fundamentals catch up.

Remember, I’m a macro trader with a time horizon of weeks to a few months, so I’m not even advocating for a static approach to this view over 12-18 months. But these longer-term views generally help to inform my opportunity set, so at the very least, I know where I’ll be looking for tactical positions over the coming time period.

If you, like me, are struggling to wrap your head around the current market action, hopefully this high-level thought experiment helps. I know I sure feel better laying this all out in front of me. If there’s one thing I’ve learned, or maybe talked myself into with a clear mind, it’s that I don’t want to be chasing the AI/Semiconductor hype right now.

And see? I promised this wouldn’t be an argument over Artificial Intelligence!!!

Best Wishes,

MC