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.