Daily Wrap – Risks Ahead and Changing Views on Leadership Dynamics
This was going to be the Afternoon Update, but I think we’ll call it the Daily Wrap.
Last week Small Caps were the winner, gaining +1.3% on the week and +5.85% over the last 2 weeks as Small Caps made an effort to seemingly rotate in. By way of comparison, last week Nasda-100 lagged with a +0.75% gain and a gain of +2.6% over the prior 2 weeks.
This week mega caps tried their hand at seemingly rotating in. Nasdaq-100 gained 3.3% on the week and Small Caps lost -1.2%. Visualizing the changing of the guard over the last 3 weeks,,,
Small Cap IWM (15m) and Nasdaq-100 (blue) with prices normalized. While Small Caps relative strength faded a it last week, Nasdaq-100’s relative strength did not start until Monday, coming back from the Thanksgiving holiday. This is one chat that supports my evolving view in which I feel much less certain that this rotation is about finding leadership, and more about preserving YTD gains into the end of the month/year.
While I could redraw Small Caps’ trend lines into something more like a wedge, so far I think the evidence is there in price action…
IWM (30m) Stalled at the post-election rally highs, but still very much in consolidation – even if it’s not the most bullish of consolidations. I’d call it a holding pattern base on my evolving view of rotational/leadership dynamics.
Small Caps would have likely ended the day lower if it weren’t for shorts getting a little more aggressive recently, which I commented on earlier this week, saying that they will provide “some” short-squeeze fodder, but not that much. My Most Shorted Index saw a much larger squeeze today than Small Caps’ moved.
IWM & MSI (2m) w/ today in green.
The Dow has not had an identifiable consolidation until yesterday with an ascending triangle (more bullish than what it was prior)…
DJIA (15m)- And even that subpar ascending triangle got sloppier today. A new trend line could be drawn at the bottom, but the price evidence suggests this is more appropriate. The market is like an evolving story. Rigid views that don’t take into account changing dynamics is more a personal ego issue than a helpful view of the market. The market is dynamic with millions of players. Things change and you must be flexible to account for those changes.
The Dow is stalled about 0.25% above the post-election knee-jerk rally high.
The S&P and Nasdaq are trending higher with the mega-caps weight this week making all of the difference. You can see that both indices only crossed above the election knee-jerk rally highs this week as both are cap-weighted indices that are heavily influenced by 10 or so mega cap stocks.
SPX (30m)
NDX (30m)
Looking at a normalized chart of the NDX and Mega Caps (MGK) you can really see the mega caps contribution to cap-weighted averages over the last 5-7 days.
Masdaq-100 (30m) with MGK in blue.
Not so much for Semiconductors, which I consider to be the canary in the coalmine for Tech, NDX and SPX…
NDX/SOX (30m normalized)
The exact trigger level for SOX is hard to know. For instance, a fast, sharp decline probably doesn’t need to come down as far to be a catalyst, but assuming we have more of the same type of trade and it’s a slower decline, I’d guess that a close below $4825 would do it.
SOX (daily) hung up at technical levels (50 and 200-day SMAs) and still trading in a less than perfect bear flag. The bear flag’s measured move of roughly -9.75% — which would give SOX a close below the trigger level — is less important to me than what the upward slanting parrellogram (flag) represents… a bearish bias in price action, despite a strong week for Tech. In other words, the character of price action is more interesting and important to me here than the measured move. Eventually, breaking the H&S neckline around $4300 is the cataclysmic event. How price trades between here and there is much more important to me in judging the probabilities of the massive downside H&S measured move. I’d place probabilities of that H&S break at roughly 80% as of now. I’d place the probabilities of that happening before the end of the December/ year-end, at roughly 20% and that would be even lower if it weren’t for a number of risks the market is ignoring. This is a H&S pattern almost 10 months in the making – even during the AI frenzy. The size of patterns and the timing tend to be proportionate, but more to the point, I don’t think institutional investors want to see that break before year-end as they try to protect YTD profits an add to them of possible. That’s pretty much been the most obvious game plan since the second half of 2024.
Of the many 3C charts I posted this week, the theme is the same as this summer before the July to early August market sell-off, and that’s selling (taking profits) into price gains, and providing enough support that when prices pull back, they are minimal corrections or consolidations. The fact that retail investors are pouring in record amounts of capital (apparent from numerous metrics – see yesterday’s Daily Wrap) is helpful as institutional supply doesn’t overwhelm retail demand when taking profits. There’s also a high probability that many of the large and mega cap stocks are executing buybacks while the buyback window is open until later this month. I think I’m seeing enough evidence to suggest that the market has less of a priority on finding new leadership, and more of a priority to continue a trend seen this summer – protecting profits and taking some profits into year-end.
The market survived this morning’s Payrolls, but didn’t thrive after Payrolls. Perhaps part of that is the increase in the unemployment rate and the increase in wages that gives more credibility to the observation that while inflation isn’t presenting a major problem at present, it’s becoming more evident that further progress on bringing down Y-o-Y inflation is stalling. This is one of the times when YoY rate o change and the second derivative, is increasingly important. Said more simply… Changes in character precede changes in trends, and that’s mostly a macroeconomic concept, but applicable to asset prices as well.
Trends don’t usually have a v-shape reversal (E.G- from progress on inflation to a sudden spike in inflation). Rather, most trends that are transitional, starting with a less noticeable shift in the rate of change. Many investors/retail don’t appreciate the rate of change, or the more subtle second derivative of the rate of change, but for professionals this is key to understanding trends – whether economic or asset prices.
As an example, here’s CPI (Consumer Price Index)…
From trending lower, to a “Chang in character.” Charts like this usually don’t get noticed unless there’s a huge change, but the huge change (the stalling out of further progress on inflation) is huge and right there for you to see.
And the same CPI on a percent change basis…
Few investors are going to scream, “Inflation is back”, but those in the know, understand that there’s a ten change underway. To me this suggests that if the Fed does cut this month by -25bp, it’s likely the last cut before a pause. Their dual mandate is leaning toward cutting to support the labor market, but cut too much an they stoke the flames of inflation. Where was this balance when inflation was soaring, they had the Fed Funds Rate at ZERO-percent, and were buying assets for a year, all the while calling inflation, “Transitory”? It’s either one of the most egregious Fed policy errors that allowed consumer felt inflation to soar above 20% in 3 years (that won’t come bac own without a recession), or there was a more ominous backroom deal going on. The Fed employs more economists than any organization in the world, yet they missed inflation? Mischaracterized it as transitory? An fanned the flames of inflation with a 0% Fed Funds Rate and asset purchases.
Even I could see it with one simple chart – the Copper-Gold ratio that was screaming that the 10-yr yield should have been at least double the 1.5% it was at back then. And even that was a conservative, too low assessment. Free markets setting interest rates would have been far better than the Fed. If anything comes of the Trump presidency, my hope is that the Fed is significantly curtailed. I’d even be onboard with ending the Fed. Fed policy alone is responsible for the exponentially widening 40-year wealth gap as Bernanke and other Fed chairs have prioritized the stock market as a measure of wealth and policies have been exclusively geared toward realizing the assumed “Wealth Effect”, except the majority of Americans don’t own assets in a meaningful enough way to benefit. As a result, the very richest of Americans benefit the most, while the rest (even if they own assets) see their net purchasing power fall over the years. Corporate profits rise, while wages on a relative basis, decline. Inflation just exacerbated the wealth gap. Are most of you seeing credit card interest rates fall meaningfully from Fed rate cuts? Did you see savings account interest rates rise during Fed rate hikes in a meaningful way? But those that have large portfolios of assets received immeasurable benefits from modest rate cuts. Politicians are held responsible. I have zero doubt that Trump’s election win was in large part, due to Americans struggling. If Trump had won in 2020, the Republicans would have been the ones suffering in tis year’s election. Yet very few Americans understand that it’s Fed policy, more than anything, that caused their suffering. Why someone hasn’t stepped forward to explain this to the average American in a meaningful way, after decades of suffering, is beyond me. So yes, I’m onboard with ending the Fed and letting free markets set rates.
There are many risks under the surface that haven’t been noticed by most investors, or taken seriously. The record setting SKEW level yesterday shows that institutional investors are aware and taking action. It costs them money and YTD profits to take out this insurance, especially so late in the year, makes these “insurance” expenditures even more interesting. They’re worried about some tail risk/s.
There are a few other risks I did not highlighted earlier today, but have done so recently. Another of the underappreciated market risks was the Bank of Japan’s (BoJ) governor, Ueda’s, comments last Friday about further Yen weakness being a risk for Japan. In fact the afternoon comments caused a weaker close among the major averages last Friday as can be seen from this chart posted a week ago.
SPX (1m last Friday) and USD/JPY (blue)
In July we got a nasty Tech sell-off that spread market wide. The most inflammatory part of the -15% to -16% NDX decline was an unwinding of the USD/JPY carry trade. While the stock market is not focused on that risk this week, it remains.
The FX pair still has a strong level of correlation to the market as the interest differential profits fund long positions in U.S. stocks, primarily Tech as we saw with July’s meltdown in Tech amid a carry trade unwind.
S&P futures (5m) and USD/JPY (blue).
However, there’s a serious and building divergence between the carry trade and the U.S. averages…
(12H) – Notice how the resurgence of the carry trade led the market off the late October lows (2023) as the averages came down from a mid-size summer H&S tops. The S&P lost about -10% into the October lows and almost perfectly met the H&S top’s measured move at $4100, coming within less than a half-percent of the target level.
The Dollar-Yen confirmed the Small Cap driven short squeeze rally off October lows into November/December of 2023. The FX pair did a pretty good job of conforming right into the carry trade unwind, which was sparked by BOJ interventions to support the Yen. July-Aug of this year the Nasdaq-100 was hammered harder than the rest of the averages as carry trade profits financed mega-cap tech longs and they had to be sold as the carry trade lost money.
Now USD/JPY is negatively diverging with the averages again. There’s no way to predict whether the BOJ intervenes again, but the BoJ meets December 18th/19th and is expected to deliver about a -16bp cut. They could surprise markets and squeeze Yen shorts, sending the carry trade lower, potentially forcing the sale of U.S. stocks financed with carry trade profits turned into losses.
On a trend basis, you can really appreciate how profits derived from the carry trade have a strong influence on stock buying/selling.
SPX (daily) & USD/JPY’s longer term trend. The FX’s pair’s support was a big reason why stocks were able to rally off the Aug./Oct. 2023 H&S downside measured move.
You can also see that the carry-trade unwind from July’s market thrashing never reconnected with stocks since. In my view, this relative strength in stocks is in large part driven by the imperative of investors trying to maintain YTD gains into the end of the year. They’ve been swimming against a less supportive tide in the Dollar-Yen.
However, more recently, we can observe the FX pair negatively diverging with the stock market.
Especially the last 3-4 weeks, and more specifically, Tech’s relative strength this week or two.
This broader view of USD/JPY is a potential problem for stocks in 2025…
That’s looking like a large H&S top in the Dollar-Yen (daily).
The more immediate risk for stocks is more recent…
USD/JPY – Building risk for equities over the last 3 weeks. Again, I can’t predict what the BoJ does. There’s a lot to consider, including tariffs and Trump administration Dollar policy (which sounds like strong Dollar policy). What I can say based on the price action of a decline and bearish consolidation, as if price is setting up for a second leg down, is that this is a serious risk that seems to be flying under the radar for most investors whose primary focus is getting through year-end holding as much YTD profits as possible.
A second leg down comes in near $142. Assuming there’s no big moves lower in stocks before then, a second leg down will exert a stronger downward gravitational pull on stocks as gains will start slimming or even turning to losses, requiring investors to close their carry trade financed longs and carry trades. In other words, this is another, different, but very real and important aspect in the mission to hold YTD profits amid an increasingly significant risk to those profits.
Another risk is the cost of financing or the cost of leverage, which is hitting pre-Financial Crisis highs.
Source: Goldman Sachs
AXW spreads measure the cost of equity leverage or how concentrated it is to be levering up into the meltup; the greater the spread, the higher the cost.
With the spread so elevated at historic highs, the cost of funding has become a meaningful drag on returns. As seen above, with the Dollar-Yen getting ugly, there’s less to no opportunity (without serious risks) to fund long equity positions via the carry trade. This comes at a time when investor complacency is extreme (as highlighted yesterday with put options virtually hated), perhaps with the exception of institutional hedging of Black Swan risk (SKEW Index).
That’s not to say that investors weren’t worried about Payrolls and hedging risk in advance of the report, as VIX (vs. SPX) shows…
(5m) 2-days of relative strength and positive correlation between VIX and SPX (green) ahead of Payrolls, then hedges dumped into the cash open today after the uncertainty of Payrolls was removed. There was another bout of stronger relative weakness into the close to help the averages with a better close to the end of the week. VIX dropped -5.75% on the day. VIX ended at session lows, but the SPX was well off session highs at the close.
With that said, VVIX tends to lead VIX more often than not…
VVIX (green) & VIX (blue)
More recently…
VVIX is acting better than VIX, suggesting we’re building toward a pickup in market volatility.
Whatever institutional investors are worried about, it wasn’t Payrolls. The SKEW Index closed at 168, so it wasn’t just the Payrolls report weighing on investors minds.
Speaking of the Jobs report, it pushed up December -25bp rate cut expectations to 87.1% from 71% before Payrolls and 66% this time last week. It also moved up 2025 rate cut expectations that were less than -75bp to -90bp.
The 10-yr yield ended 4 bp lower on the week, but brought yields down from the danger zone (red), which likely opened the door for mega caps to perform better this week.
10-yr yield (daily) with the danger zone for stocks in red and this week in green.
If nothing changes with commodity prices, especially crude oil (given all of the geopolitical turmoil and upcoming tariffs, I doubt prices remain static), then the Copper-Gold ratio…
Suggests the 10-yr yield has about another 40 bp of downside, pretty much erasing all of the rise in yields since the Fed cut in September.
I do think we’ll get a long TLT trend trade in 2025, but I don’t see price action as being there yet.
TLT (weekly)
In crypto, Bitcoin traded above $100,000 for the first time ever, but wasn’t able to hold it yesterday. It’s back above $100k today.
(daily) – I am bullish on a few cryptos. I don’t like the last 2 days of price action with yesterday’s heavy volume on a failure to hold $100k, and today’s light volume on a second attempt that’s yet to take out the highs from yesterday at $103,647.
And then there’s this…
U.S. Dollar Index (60m) and BTC futures – Almost a month ago I pointed out that Bitcoin does well in a strong Dollar policy environment with a very high positive correlation over 90% on a 30-day basis. The Dollar and Bitcoin are diverging right as BTC tried to take on what’s now the most important level in its history.
Ethereum is up over +6% and up 4 of the last 5 weeks, and is outperforming Bitcoin.
(daily) – Since mentioning it as a long trade idea, I do like ETH better than BTC, although it does have a more challenging price environment to contend with. I do think the laggard status relative to BTC’s performance means it’s more likely to have a stronger “catch up” effect. There is a correlation with the Dollar too, although not as strong as BTC. The price action looks better, especially since breaking out above $3400 with strong follow-through. I do have the same concern about volume not being as heavy as I’d like to see today. I continue to expect ETH to perform better than BTC, but between volume and the Dollar’s divergence, I wouldn’t be surprised to see a consolidation next week.
Coinbase (COIN) gained +7.2% today, but like cryptos, has some recent trade that’s slightly bothersome.
COIN (30m) – Like bitcoin, it broke out again today, but hasn’t surpassed yesterday’s intraday high. I’m not overly concerned, but the breakout is almost always the most dangerous time in a bullish consolidation. It can pull back to the lower trend line and I’m fine with it, but I do not want to see price close below it as that starts to look like a failed breakout/fast reversal scenario. Overall, I think this is a strong chart, but we do need to be aware of the risks.
Another Trump, or rather RFK, trade that I mentioned was in psychedelics, Mind Medicine MindMed (MNMD) . It went through the initial election knee-jerk trade higher, then consolidated.
(60m) I consider this a very speculative trade. It could do amazing if RFK is able to fulfil his hopes of legalizing psychedelics, but there’s a lot of potential pushback from Congress. I’d make sure position sizing reflects the speculative nature of this idea. I’m fine with price action so long as it doesn’t close below $7.00. On the recent pull back to $7, 3C showed support there.
MNMD (1m)
I also still really like URA (Uranium ETF). I see a lot of possibilities for it moving forward, especially with major Tech companies getting involved in nuclear power to provide for AI power needs. This has been a longer term investment since the first day I brought it up, not a trade.
(weekly)- Just from the price action on this chart, the next leg up could easily double price. Next up is $33.65 which is the resistance level to take out to start that next leg up. I hoped price would take out $32.50 and then consolidate before trying for $33.65 and so far, that’s exactly what it has done.
(daily) – The bullish ascending triangle could have other interpretations for the consolidation and I wouldn’t argue with anyone making that case, but with a fairly clear flat-line resistance and price making higher lows in the consolidation (bullish), I thought this was the most appropriate. Even the 1 day of heavy red volume is bullish as that day was a star candle right at the lower trend line (support) – the heavy volume represents seller capitulation and stronger hands taking positions. If I had to guess when it beaks out, I’d say before the end of the first week of January, assuming this price consolidation doesn’t change.
This is the type of stock that if I were time constrained and wasn’t watching the market all day, I’d set some price alerts or check in once a week or so. I don’t feel like it’s the type of stock/ETF that needs constant baby sitting.
Based on how 3C charts ended the week, I put probabilities of most of the averages correcting or consolidating next week.
SPY (1m)
Here’s the trend I’ve referred to as profit taking…
SPY (2m) – And this trend has been obvious much more often than not since summer time.
QQQ (1m) – Here we can see 3C calling out profit taking into this week’s higher prices in Tech/NDX – starting the first day of the new month/Monday in which Nasdaq started outperformance over Small Caps.
This is another piece of evidence that’s changed my mind about the market trying to find leadership, but rather moving back and forth between sector types so the broader market doesn’t get too overbought. Every day this week we had S&P sectors mixed with half up and half down. There’s only so much profit taking that can be done without damaging the trend.
And if there’s any rotational dynamics, I favor Small Caps performing better next week.
IWM’s (1m) 3C chart improved notably above and beyond the other averages this afternoon. That suggests to me that the mega-caps correct/consolidate (rest) next week, while Small Caps get back in the game. It’s not a whole lot of information to go off, but it does seem pretty clear and support probabilities based on the information we do have.
I hope you have a fantastic weekend! I hope I do too!