What's the purpose of the market again?

The beach ball analogy I wrote about last post was spot on. The market has exploded to the upside just like I suspected would happen and to hit new highs. Once again for the umpteenth time the market did what it always does which is make fools of as many people as possible. I'm not sure if anyone reads these posts but if you're a long time reader and you're still not a believer in the motto of this blog you are in denial and you are probably a dogmatic investor which has only served to hurt you.

Ok, so what's happened since my last post? Well, we've seen continued talks/hopes to put an end to the war, but it's still ongoing. It's difficult to tell, but it seems there are different factions in Iran fighting for power. We've seen the US put more pressure on Iran by creating a blockade. Trump has been under tremendous pressure from all sides including that of this own supporters many of which have turned on him. I'm not a fan of Trump at all. He's a serial liar/gross exaggerator, narcissistic, and not to mention criminal.  But, he's resilient and heavy handed, the latter trait can be a good or bad thing. When it comes to dealing with authoritarian  or criminal enterprises, it's a good thing because things like diplomacy, leniency, a show of "good faith" don't work as these things are the opposite of how these people operate - they achieved and held their position through force, brutality, manipulation, and deception and as such ,you have to fight force with force. When you use "diplomacy" to negotiate with such people they will just take advantage and stick it to you which Iran has done repeatedly over the past several years.  Iran is an evil empire. When you brainwash kids with the slogan "death to America, death to Israel" how can you just sit there idlily forever?  I'm not sure if this was the right time to strike Iran, but when is the right time? When they have built up their miliary might and influence to the point where action is all but forced to be taken? By then it could be too late or more more difficult/consequential to deal with. When Nazi Germany first started wrecking havoc in Europe, the allied forces used "diplomacy" to appease them. Only when it was so painfully obvious that they had to use force did they act. Imagine if they would have used force sooner?  How much damage and loss of lives could have been spared? And if Hitler didn't make the fatal mistake of turning on Russia he could have very well been successful. The easy/diplomatic way to handle Iran was just to put sanctions on them and monitor them. That didn't work. They still found ways to smuggle goods in and out. So what do you do? You just sit there and let them accumulate/build up their military capacity? A nation led by fanatics that have openly admitted to want to destroy the Western way of life? 

Whether or not it was the right time to strike Iran, now that they have, the US/Israel need to finish the job despite the political pressure. The media is trying really hard to make it look like Iran is somehow winning this war which is a joke. Yes, they are clearly being defiant and creating some havoc, but to suggest they are winning given the damage they have sustained economically and militarily is a joke. Meanwhile, despite oil prices rising sharply, they aren't at a level that would be considered catastrophic. Gasoline prices in the US are currently a bit higher than what they averaged from the high gas price era of  2011-2014 which at that time didn't sink the economy. When you adjust for inflation, the gas price would need to be at about $4.60 today to be what they averaged in real terms back then. When you take into account today's vehicles are 15-20% more fuel efficient, you would need to see gas prices at $5.30+ today to match that high gas price era which didn't sink the economy anyways.

Let's get back to the market here. The fact that we have hit new all time highs should be a loud and clear signal that this Iran war is ultimately not going to matter as far as the stock market/economy is concerned longer term.  The market is saying that somehow, someway the economy will be resilient, whether that be via re-routing of cargo ships, an end to the conflict soon or whatever. If reading that last sentence makes you hot under the collar, you need to let go of your dogma and/or you hatred of Trump, Israel or whatever else is making you biased. You're not listening to the message of the market.  Could this rally end up being the mother of all head fakes?  Of course it can, but it's unlikely because by now, the market has has more than enough time to digest/price in the Iran war situation and it's telling you that it doesn't believe it will derail the economy, just like how it correctly saw through the tariff drama of last year. Does that means there can't be any flare ups/headline risks that create more volatility? Of course not, but it would likely end up being noise....this is what the message of the market suggests! Don't shoot the massager! 

Having said all this, the market hit extreme ST overbought conditions recently, put/call ratios have collapsed, NAAIM is at 94% exposure, AAII bulls have popped to 46% while bears dropped to 34% which is almost the inverse of what it was a few weeks ago. This suggests the wall of worry needs some re-building and the market is vulnerable to a pullback/ consolidation phase.  But, I very much doubt the average investor out there is feeling truly complacent about the market over the next few months given the war and continued blocking of Hormuz. I know this must be true, because I certainty feel uncomfortable/skittish about things.   And here's another thing....the longer you wait for confirmation that the war is over or that thing's aren't going to be as bad a you feared, the higher the market is going to be. You will have to pay up for certainty....and probably not too far away from he next market scare to hit!

  

Market in denial or like a beach ball held under the water?

We've seen the market snap back since my last post up about 4% from the lowest point of this decline despite oil rocketing up 11% to  $111 on Thursday after Trump's state of union address the night prior. I found this oil price reaction strange because Trump didn't exactly say anything new or that surprising. The market opened up down 1.5% but by the end the day clawed back to even. This must have been infuriating to the bears. I can just hear them yell "how the fuck can the market be flat with oil soaring like this?" If I was short, I would be very worried of this action. The market is acting like a beach ball being held under water....more on this later. 

Although Trump says that the straight of Hormuz is Asia and Europe's problem and that they are the ones who should sort it out, the US military build up suggests that they are planning to pry open the straight by force as I had mentioned in the prior post. Although the US doesn't heavily rely on energy supply from the straight, the impact of the high global pricing of energy is felt by everyone and if there's one thing we know about Trump is that he wants low energy prices...that has always been his mantra. If we don't do anything and just allow Iran and its proxies to be able to attack energy supply lines like this with impunity they will hold the world hostage anytime they want something. Yes, the US started this war and Iran is retaliating but now they learned something from this and would be inclined to use this tactic going forward. Iran is actually allowing some ships to pass so long as they pay a toll which means they are profiting from this situation, yet another "why didn't we think of this before" epiphany for them. The bottom line is that when it comes to war, diplomacy is not going to work. Only force works. Only when enough force has been applied does diplomacy eventually work as the nation who is all but defeated has no choice to accept it, especially a brutal regime like Iran. So long as the straight of Hormuz is in Iran's control, this war is likely not going to end with diplomacy. Last week a coalition of 40 Nations discussed diplomatic and economic strategies to open the straight, in other words. sanctions. This is probably not going to amount to much. Iran has been sanctioned to the wazoo for decades already. Macron says miliary force must not used to open the straight. Good luck with that. Why would Iran give up their biggest leverage in this war? But sure, go ahead and try to see if Iran will be "diplomatic"...just don't hold your breath. 

Let's get back to the markets. As of now with this latest little rebound, the market is only down about 5.5% from the all time high earlier this year. This is pretty incredible considering that oil prices have doubled in 3 months and 20% of the world's oil and gas supply has been cut off in addition to other things. There's 2 ways to look at this...either the market is in denial or the market is looking across the valley and sees this as temporary. Most evidence suggests the latter in my opinion. Oil futures for delivery in August and December are trading at $82.50 and $72 respectively. This is a massive discount to spot which indicates the market is pricing in much lower prices in the not too distant future...I know there's more to it than this but this is likely the main reason for this pricing. More often  than not, steep differences in futures prices to spot like this signal the spot price is unsustainable and destined to go the other way.  I pointed out this disparity last post, but now the situation is even more extreme because the longer dated futures are trading LOWER than they were 2 weeks ago despite the fact that spot prices are higher. Some people would argue that this is complacency, that this indicates denial. History suggests otherwise. 

Another thing to look at is the 5 year break even inflation rate implied by TIPs. I've quoted this indicator before as far back as late 2022 to suggest that the market was pricing in much lower future CPI inflation going forward from that time which hardly anyone believed. Well, it turned out that the market was indeed correct. While the TIPs market under estimated the actual inflation realized, it was directionally correct when spreads started falling significantly in late 2022 just like how it was directionally correct in mid 2021 when it was ramping signaling an inflation surge forthcoming while the US and CDN Feds had their dicks in hand saying "lower rates for much longer". So what's the 5-year breakeven spread saying now? While it has up ticked since the war broke out, it's currently at 2.56% which is near the higher end of the range it's been for the past 3 years and has not made a higher high despite oil making one on Friday. What this means is that the market is not expecting  inflation to dramatically surge otherwise it would have definitively broken out to new 52 week highs. The same message can be seen in the 2 year TIPs market, in fact, it's at 2.27% and  near the mid point of its 3 year range which is an even stronger signal that the market does not expect significant inflation pressures forthcoming in the near term. Once again, the skeptic would argue that the TIPs market is being complacent but history shows that the TIPs market tends to get it right....not necessarily right in the average CPI it implied (which can be off by 1-1.5%), but the direction of the CPI trend. 

I mentioned last post how some sentiment indicators have already hit extremes. Here's some more evidence of that

I would say that the sentiment reset overall is not extreme as it was last year at this time, but it's defiantly notable and enough to suggest that a bottom is in or close. AAII sentiment and II sentiment are now at pessimistic levels commensurate with some prior market lows. AAII bearish sentiment has averaged about 50% for the past 4 weeks, while the slower moving II bull to bear ratio is currently at 1.12 which is quite low. Ideally, I'd like to see it at 1 or less (which can happen this week), but at 1.12, that's already a big reset especially for a market that is off only 5.5% from the high. At the market high, the ratio was 4. So, sentiment has rapidly cooled. Can it get cooler? Of course, but it has cooled off enough for the market to resume its uptrend should the proper catalyst(s) slow up. Another thing I have noticed is how the put/call ratio has been at or near 1 throughout this recent pop in the market. That shows you folks are shorting/hedging aggressively into strength which usually means the rally has legs to go higher still. Ideally, I'd like to have seen NAAIM exposure be lower as it's currently at 68, but I know from experience, not every indicator is going to perfectly line up. 

The market has had plenty of time now to price in the situation in Iran. It has taken limited damage given what seems to be a very serious situation with the Straight closure which gives me the analogous feeling of a beach ball that is being held under the water...you can push it down but not much and once that artificial pressure is released, the beach ball pops up violently. I realize I could end up looking like a total clown making this claim, but this is how I feel about the market at this point. Always remember the motto of this blog. How would the market create the most amount of fools right now? By going down another 5-10% or going up 5-10% making new all time highs? It would seems the latter is a near impossibility at this point....and that's why you should be prepared for it. I feel squeamish making this post...let's see how it turns out. 

War

What a difference a month makes. In my last post I mentioned how the market structure suggested more downside was in store and lo and behold we got the downside I expected and then some. Unless you've been living under a rock, it's obvious why the market has been going down. Since the start of the year I've been more or less  been saying that the market was overheated...running on fumes is a term I had used. With the market down about 10% from the recent peak, we have seen a very significant reset in sentiment. In fact, some sentiment indicators have reset to levels seen near seen near major market lows. Here are a couple of them:

It should be noted that the CTA positioning chart was as of March 23 and so it is probably at an even lower reading right now. At the very least, it would appear that the market is near a ST low. Having said that, it would not surprise me to see further downside Monday...at least initially, just given how the market closed at the lows of the day on Friday making a new low for this move down. 

So, let's talk about this war. Why did the US invade is the question a lot of people are asking. In my opinion it was because of Israel. Israel always wanted this war because Iran has been a threat to them directly and though the proxies they support. They just needed an excuse to attack. Given Trump's "success" in Venezuela in toppling a regime and installing someone who was co-operative with the US, he was probably convinced by Israel that he could get the same result in Iran especially given the protests earlier in the year which suggested that Iran was ready for a change. There's no shortage of criticism about the US administration's handling of this war pointing out how they don't appear to have a gameplan and they keep changing the narrative. I have little faith in Trump's decision making ability during this war, but I'm more hopeful of the Israelis . These folks are sharp cookies when it comes to tactics. Just look at how they got to to those Hezbolah fighters with the explosive pagers and how they have been able to assassinate Iranian leaders so quickly. Most pundits are saying that the US underestimated Iran's capabilities, but do you think Israel did? I don't.  Given that Iran is their largest enemy they must have known all about Iran's missile cities and drone capabilities and so if they decided to strike them, they must have calculated that with the help of  the US, they can defeat Iran. You have 2 vastly superior forces against 1. Yes, the asymmetric attacks are a problem, but they can't be sustained given that the US and Israel have total air and Navy dominance knocking out targets at will. Iranian Ballistic missile attacks have slowed to a trickle and drone swarms are still a problem, but have slowed down significantly.

With 3500 US marines arriving in the Gulf,  a lot of people are worried that this signals an immanent ground invasion, perhaps of Kharg island. I seriously doubt that.  It's more likely they are being brought in primarily to secure the straight of Hormuz. If that can be established, Iran loses its only bargaining chip and so that suggests they would be more willing to come to the table sooner rather than later. 

Regardless of how this war turns out, one thing that is almost a certainty is that this will be a major boon for safe US, Canadian, and Australian energy i.e. LNG and oil as the war exposed the vulnerabilities of energy supply from the Gulf region. So, assuming that this war doesn't end up spiraling into a total catastrophe, Trump could  end up looking like an evil genius even though he probably didn't it plan to.  

December NYMEX oil futures are trading at $77 which is a significant discount/backwardation to spot price of $99 and tells you that the oil market expects oil prices to decline significantly longer term. This doesn't mean oil prices will drop tomorrow and there's no guarantee that the market gets this right, but when you see such a disconnect between spot and futures prices in commodities markets like this, in my experience I have found that the market does in fact get it right more often than not and the stats prove it. The last time we saw this degree of backwardation in the oil market was at the peak of oil spike in 2022 after the Ukraine war broke out. After the COVID meltdown the opposite condition was in place whereby longer term futures prices were much higher than spot. 

Final comments. It would not surprise me if we see further downside action early this week given the downside momentum that is in place and the scary headlines. However, given the condition of sentiment indicators, if we get some sort of downside puke, that would suggest we are close to or at a bottom. I certainly have a nauseating feeling about this market which suggests we may be close. I'm also not underestimating the seriousness of the current situation. It's terrible and things could get really worse, it's just that I see some possibilities/signs for things to get better even though the media is suggesting the opposite. 

Software glitch

The market structure right now is quite unusual. The average stock is doing well but the Big Cap Tech stocks have not thanks to the meltdown in the software sector sparked by fears that AI will be able to replicate what these firms do which started when Anthropic released  new AI tools. This has similar vibes to the "Deep Seek" sell-off from last year. One could suspect that a sector wide sell-off like this would present opportunity as the baby is being thrown out with the bathwater. This could very well be the case here...but is it? Dan Ives, arguably the most widely know AI bull says that the decline in software sector is the biggest disconnect he has seen in his career. According to Ives, switching costs, embedded workflows, and long‑term contracts make it impossible for AI agents to displace major platforms overnight. I asked co-pilot to analyze the situation and it agreed with Ives' assessment but also stated that there will likely be causalities in the simpler, basic level services.  It also recognized that Ives is a noted permabull and to take his views with a grain of salt. My first instinct was to agree with Ives' take because the software sell-off was so widespread and knee-jerky. That doesn't mean we can't see further downside however. Tech has been the market leader for so long which means there was no doubt a notable amount of momo/trend following money on board. These group of "investors" are weak handed and will get flushed out in situations like this. Has selling from this group ran its course yet is the question.  

I'm going to take a look at the chart of the S&P 500 and the VIX and analyze it from a "waking up from a 5 year coma" point of view which means, no knowledge and hence no biases from recent events....just looking at things from a purely objective technical point of view. 

My coma take of the S&P 500 chart is that it looks top heavy threatening to break below 6800. The market has failed to make higher highs recently. A healthy uptrend would have seen  a higher low on that early Feb pullback  but instead the low was made at about the same 6800ish level in mid-Jan and now we are threatening 6800 again. The more times you test a certain level, the less likely it is to hold.  Meanwhile the VIX  is in a nascent uptrend, making higher lows and looks poised to break out to 25 at least  So, the bearish  message I get from both charts corroborates each other suggesting we are on the cusp of at least a 4% pullback from the recent market peak. This is my unbiased view of these charts. Some may disagree I'm sure, but that's how I see it. If I'm right, then we need to brace for some more downside. 

Now let's bring back the narratives. If we indeed have a throw the baby with the bathwater situation here with the software sector\ a flush below 6800 makes it likely to be the final stages of the pullback/correction rather than the start of something worse. Let's see how this plays out....  

What's up with Gold and crypto?

The day after my previous post the market had a 2% drop due to the escalation I had pointed out, but then Trump walked back his Greenland threats by announcing there was a "framework" in place between the US and Europe to have joint co-operation in Greenland to allow for increased military presence and perhaps other things like resource extraction.  As the result, the market recouped all the losses in short time.

We've seen a parabolic run and now sharp correction in Gold and its more speculative sibling Silver. I've been meaning to discuss Gold for while. This run in Gold has been underpinned by 3 forces. The first one started 4 years ago after the US weaponized the US dollar by freezing  Russian US dollar reserves. As a response to this weaponizing, central banks around the world ramped up their Gold reserve purchases. The next force has been the decline in the US dollar which is arguably mainly due to concerns about excessive deficit spending. The 3rd driving force has been Trump's obnoxious actions which as created, to use one of his favorite words, "tremendous" uncertainty and disdain of the US from foreigners. Gold took a dive Friday shortly after it was revealed that Kevin Warsh was chosen by Trump to be the new Fed Head. Since Warsh is considered a monetary "hawk" by Wallsttreet, that would imply less chance of rate cuts which supposedly is supportive for the US dollar and hence weakens the 2nd driving force that has been driving gold higher. This is quite a weak excuse for a correction. First of all, this idea that the level of the interest rate is a primary driver  of a currency's value is simply false. Most of the weakest preforming currencies over the past several years have the highest interest rates.  Secondly, Warsh has indicated he is actually receptive to the idea of lowering interest recently because of lower inflation pressures, but since he has this reputation of being hawk, people seem to be more focused on that. It doesn't take much of an excuse to trigger a correction when something has been running red hot like Gold has...I just have serious doubts that the trigger - the nomination of Warsh -  is going to end up being the reason that the gold bull market or bubble has ended. By the way, why isn't anyone calling this Gold run a bubble?  The parabolic nature of its rise suggest it is one. Regardless, I have my doubts this Warsh sell-off is going to end up marking the end of this gold run just yet unless we see other things happen in the near future that truly weaken 1 or more of the 3 mentioned driving forces of Gold.  

Now onto crypto. I'll be quick to admit that I severely underestimated the length and heights of the BTC run. I have been on record to state that BTC and all other crypto are simply being underpinned by greater fool buying. BTC, having been the OG of crypto has been able to recruit the greatest amount of greater fools, far more that I thought possible. What is BTC actually useful for aside for criminal activity? Fuck all.  I'm sure someone can create a crypto coin superior to BTC when it comes to things like  power consumption, costs, scalability, ect. just how how the first computer or any other tech product was never the best one.   But even creating a better version of BTC doesn't make it worth anything  unless you can convince the masses that it does just like BTC did when if first came out, just like the meme stocks did in 2021.  It's essentially the same as a religious belief.   Ultimately though reality prevails.  In the case of BTC, it had the same reasons to go parabolic just like Gold did but it didn't. Why? It's probably because it may have finally ran out of greater fools whereas with Gold, it did not attract the greater fool crowd until just recently. Gold was actually money, not just in ancient times, but in recent times going back to 1970s when the US dollar was backed/convertible to gold.  So, if there's going to a be true crisis in confidence in paper money, i..e the US dollar,  Gold  is likely to be the winner, because it's been used as a currency before and the reason for that was because it has a tangible aspect to it that everyone around the world recognizes and uses. Gold would not be the only winner, other commodities, and tangle assets like land, real estate, food would appreciate notably. You could argue that in really dire economic collapse scenario it would be only the essential commodities that hold value the best. How much do you think your BTC would be worth in that scenario? Less than nothing.   

Anyhow, I could once again be under-estimating the persistence and pool of the greater fool buyers of BTC and this ends up being just another temporary downturn but I gotta tell you ,the action in BTC is not a good look here given what should be a bullish environment for it.  There's no shortage of buy the dip crypto bros on twitter. but you need NEW greater fools to keep the party going longer term not just circle jerking. We'll see what happens...

Escalation

The Maduro capture turned out to be a non-event as far as market impact goes. My parents used to own a condo in Venezuela back in 90s in Margarita Island to which I have fond memories of. My initial reaction to Maduro's capture was one of positivity as this tyrant has clearly caused tremendous misery for its people. Although I knew the US didn't do this out of the kindness of their heart, I figured it was a good thing to see this guy go. But then I learned that the VP and its military/militia/police  who are loyal to her are left in charge continuing with the same oppressive regime while the US doesn't support the truly elected opposition leader. Given the ease to which the US was able to secure Maduro, I would not be surprised to learn that the VP had a hand in it with the understanding that she would be allowed to become in charge. Sadly, without a full scale change of the loyalty of the military/police away from dictatorship and towards a democratically elected government, Venezuelans will continue to live in misery. The level of corruption woven into the fabric of Venezuela's political and economic system may be too great to undo as is the case with similar basket case,  authoritarian regimes. You know I'm not a doomer, but I gotta tell it like I see it. Let's hope I'm proven wrong. 

I am all for the use of force by a foreign country to remove an oppressive dictator but it has to be done right. First of all, the argument of "don't meddle and just let the people overthrow the government" doesn't hold water in many cases because the people are often powerless and are effectively prisoners in situations where the military/police are loyal to the oppressive government.  And when in comes to authoritarian leaders, you have to fight force with force. Diplomacy does not work. If however, an oppressive government is removed by force,  there needs to be proper plan in place to ensure a successful democratic transition and that's clearly not easy.  It would require the use of the foreign country's resources including their own military and people for several years  It is also difficult to uproot enough of the corruption and those who are still loyal to the oppressive government who are lurking in the shadows just waiting for their moment to usurp.. It doesn't seem the US is not interested in making the type of  commitments needed to ensure Venezuela becomes a free and democratic country. As we all know, the US failed in their attempts to reform Iraq, Libya, and Afghanistan when they ousted their dictators 

Now there's talks again about Trump wanting Greenland. Throw Iran tensions in the mix and it would seem likely that Trump is not done meddling around. He  appears to be serious about acquiring/occupying Greenland. Treasury Secretary Scott Bessent recently said Trump will not back down from acquiring Greenland, arguing Europe is too weak to ensure its own security. This reminds me of the tariff situation last year at this time. We all knew Trump wanted to implement significant tariffs but most of us thought this was largely a bluff and that he would settle for a lot less. Although that eventually ended up being the case, it sure wasn't initially when the "liberation day" plan was unveiled.  It would appear that this rising geopolitical tension is going to eventually hit the stock market given the market has a running of fumes feel to it.  As I've stated before, the longer we go without a sizeable 3-5% pullback, the greater the chance a larger 10% type pullback ends up occurring at this point. I can see that the futures are down 1% as the market is closed today. The recent comments from Trump and Bessent are giving me a clear sense of escalation and it looks like the markets may be feeling it too....we'll soon see.   

 

Quick follow up

The following chart pretty much captures why I have mixed feelings about 2026. It shows US financial conditions.  This indicator should be used as a contrarian indicator. As you can see, when conditions are very accommodative, i.e. above 1 for at least a few months, the markets were close to making a significant peak and conversely, when conditions were tight, i.e. below -1, the market was close to making a significant low. 

This is not a perfect indicator (no single indicator is).  It will not give advance warning to declines as a result of exogenous shocks like COVID and "Liberation day" because these are negative events that essentially came out of nowhere. It should also be noted that in 2014 when this indicator flashed red, the market still had a good year returning 14% with the largest correction being 8.5% . Then, in 2015 the SPX had a flat year with the largest correction being 12.5%. So, it would have been best to have ignored the warning in 2014. Currently, we are just below the 1 level after having touched it very briefly in October. This suggests the market is much closer to a top than a bottom but also that there's still room for the market to go higher  before reaching redline territory, although that shouldn't be taken as a given. This pretty much sums up my feelings of the market based upon my observations of several intermediate term sentiment indicators which is this: there is still room to run but we would be redlining should that happen without a correction of at least 5-10%. which would  then set us up for a even larger decline. 

News flash: The US has captured Maduro and made military strikes in Venezuela. Let's see how markets respond on Monday.