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Institutional Investor Exposure

The NAAIM Exposure Index survey tells you how invested institutional asset managers are, week to week. Readings above 100 mean they are leveraged long. Throughout history, red-hot readings like this are a short-term warning sign.

This doesn’t mean a recession is nearby, it just means the risk-reward of being long the S&P 500 is pretty darn poor for the coming weeks.

VIX Put / Call Ratio

When it comes to analyzing markets - one indicator is never enough to make a thesis. It is always about “the mosaic”…

On that front, when we look elsewhere in markets, everybody is short the VIX!

The put/call ratio of the VIX index is now at its lowest level in many years. Shorting volatility = betting against downside in stocks.

VIX calls are cheap. Betting against US stocks is cheap. Full stop.

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Rolling Correlation: S&P 500 Index vs. Stocks in Index

Continuing with our mosaic theme, this is an amazing chart - data this far back is hard to come by.

The rolling correlation of the S&P 500 and the stocks within the index has been virtually ZERO over the past 3 months. This is by far the most extreme lack of correlation in history.

Keep in mind, this is intertwined with the previous data. Volatility selling, options trading, and more - there a humongous forces that are structurally suppressing the volatility of the S&P 500 and the ‘output’ of that suppression is low correlations. We have written about those forces in previous notes.

However, the important point now is that this dynamic is NOT sustainable. In our view, index volatility is a COILED SPRING waiting to unwind.

China Credit Impulse Fading

If you are relatively new to markets - this was THE indicator back in the 2010s. With much less fiscal policy around the world, China’s credit expansion was the marginal driver of economic growth for a long time. Just because everyone has stopped watching it - doesn’t mean it no longer matters.

Is the AI theme dependent on Chinese growth? Of course not.

However, does Chinese growth still dictate a sizeable portion of global GDP momentum and thus US multi-national corporate earnings? Yes!

It may be a smaller piece of the puzzle, but it is still a part of the mosaic.

Risk-reward doesn’t look attractive here in stocks.

Japanese Machine Orders for Robots!

We try to make this point again and again. Just because you are bearish the index, just because you have hedges on, does not mean you shouldn’t be long something! There is always a trade somewhere.

So we like buying index puts, buying VIX calls for the near-term. However, we are actively searching for areas to add to into the next drawdown.

Overall, we continue to favor international assets relative to US equities. While Japanese equity indexes (EWJ ETF for example) have become a bit ‘too’ correlated to the US AI trade for our liking, their investments in robotics are telling for where we are heading. Japanese machine orders for industrial robots are up 25% YoY.

We think there are many robotics and 3d printing stocks globally that are completely undervalued. It is clearly where AI needs to head if the sector wants to create ‘actual’ productivity gains.

But for that - you’ll need to wait for the next note!

In our next report we’ll share some of our broad equity screening finds - and hopefully broad market pain is making appealing names even more attractive.

Cheers!

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Bitcoin Strength Points to… More Strength

While rumors of positive legislative development had bitcoin holding up relative to stocks in recent weeks, Bessent’s Treasury buyback announcement acted as a gunshot… and we were off to the races.

Bitcoin traded up over 5% in the last 3 days of the week, surging over 20% in total. It was the largest 1-week rally since early 2023.

Importantly, previous surges after a period of consolidation tended to be very early in rallies. We back pullback in the next few days, but with a multi-month view, this looks like the beginning of a new bull market.

We continue to favor a combination of crypto and gold here relative to US equities.

Equal-Weight S&P 500: Mid-Term Seasonals

Why don’t we like equities? Reason number 1 is ugly seasonals.

In mid-term election years since 1990, the equal-weight S&P 500 has peaked on 8/18 on average before a 7-8% pullback into mid-October.

Negative Correlation Between High and Low Risk Stocks

Reason number 2 is that equity volatility has also been suppressed by negative correlations. Think about it… if you have 2 groups of stocks (high risk and low risk) that are in the same index and they are moving in opposite directions, that keeps the index itself relatively flat.

The problem is this negative correlation is in itself a completely unheard of phenomenon. In general, stocks should move in the same direction over time.

The point is, if this correlation spikes back into positive territory (which is inevitable) it either means we rip higher or plunge lower. The sideways price action cannot last forever.

We think the direction for stocks is lower.

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Warning Signs from Credit

Reason number 3 is there are warning signs beneath the hood. The weakest areas of credit (CCC-rated bonds) have been weakening throughout the last few months, while the S&P 500 has completely diverged to new highs.

While similar divergences have happened many times before, they were commonly at secular market peaks. The exact same thing happened in 1999 and early 2000.

Long-Term Earnings Estimates

And the final reason we believe US equities have very poor risk reward is due to completely ignorant assumptions. The long-term S&P 500 EPS growth rate currently expected by markets is at all-time highs.

25% earnings growth for multiple straight years.

While that is impossible without much higher inflation - the more important point is excess optimism at these levels (see 2000 and 2021) commonly precedes large equity drawdowns.

Portfolio Implications

Being bearish US stocks doesn’t not mean your portfolio needs to be 100% cash. We continue to love gold and we like bitcoin. The sovereign debt bubbles will of course be met with money printing at some point. The point is - those are structural long-term portfolio positions.

At these levels, US equities are not.

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Bubble Sentiment

Bank of America’s Bull-Bear Indicator just reached one of the strongest stock market sell signals this century. Unsurprisingly, sentiment is at bubble levels.

Leverage is Re-Building

After the faintest of resets at the end of July, leverage in the system is slowly re-building. Leveraged trading ETFs currently have a combined $184 Billion of Assets Under Management, up 30% YoY.

We were shouting from the rooftops in early June that the leverage in the semiconductor space was over-heated. As expected, these pockets have degrossed significantly over the past few months, but somewhat surprising, is how well the broader market has held up.

Volatility at the Lows

The VIX Volatility Index is now at its lows for the year. Bessent’s intervention of the Japanese Yen was a big driver here. The one big tail risk at the end of July got taken off the table and Vol was crushed as traders headed to the beach (actually though).

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Margins Within Artificial Intelligence

Torsten Slok at Apollo came out with a great chart last week. (If you don’t subscribe to the ‘Daily Spark’ it is highly recommended).

All of the profits in AI are going to capex-beneficiaries. The actual models themselves are incredibly unprofitable. Given the size of the build-out expected (3%+ of GDP, trillions of dollars in the coming years), this is wildly unsustainable. With all of the inter-connected financing and web of equity deals, it is CLEARLY a house of cards.

As a reminder, this is not a comment on the technology itself. OF COURSE artificial intelligence will continue to grow and change the world. That doesn’t mean the current valuations and the cross-correlations in the space don’t wreak of a near-term bubble.

S&P 500 vs. Equal-Weight S&P in the Dot-Com Boom

As we have seen since early June with semiconductors down meaningfully off the highs, a bubble popping does not mean every stock goes down. This was the main lesson of the dot-com bubble. There are definitely places to hide.

The S&P 500 fell 28.5% from the Dot Com Bubble peak on 3/24/2000 through September 2001. Had you owned the S&P 500 Equal Weight during that stretch, you would have been in the green by 1%.

China is Buying Gold Again

While ‘places to hide’ are nice, you obviously want something with tail-winds.

With that in mind, we continue to like gold. Since we put it back on the radar a few weeks ago, it has begun to break-out to the upside, which has coincided with Chinese demand picking back up.

The gold bull case boils down to this….

Rising sovereign yields are the biggest problem for Governments (and corporations). It is pretty amazing that equity have been able to shun them off, but they have been rising so slowly it hasn’t upset volatility markets. However, with a long-term view, the only way Governments (including the USA) can keep yields down is via fiat debasement.

Long equal-weight S&P as a bet against the AI-bubble, and hedge the tail-risk (rising yields) with the most convex asset. GOLD.

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Last week saw the 2nd largest Hedge Fund de-grossing of the last decade. Clearly, this was heavily driven by the liquidations at Situational Awareness. If you have been living under a - that is kid hedge fund manager Leopold’s firm.

While we saw a sharp bounce in many of the names his fund held on Thursday, most of the names are only back to where they were trading a few weeks ago.

While we won’t add to the endless discourse on Leopold, the one takeaway is to maybe NOT 4x lever all of your equity holdings?

Lessons From Bill Hwang

The Leopold liquidation was extremely similar to the Bill Hwang saga. Again, if you were under a rock in 2021, Bill Hwang lost tens of billions a few years ago after levering-up his portfolio via total return swaps (and then went to prison). It is always leverage that kills you.

However, the important takeaway is that all the names that Bill added fuel to the fire on, never recovered.

As Quantian pointed out this week, Hwang’s top holdings normalized to the margin call unwind, bounced about ~10% off the lows, still well above the initial entry prices in Oct-Nov, then went down 50% over the next 9 months.

We are still in the camp that the semiconductor bubble has popped.

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CTAs Already Long

Part of the reason we are in this camp is because you would need a lot of buyers to push Leopold’s basket of AI-capex beneficiaries back to all-time highs, and much of the investment community is already long. CTAs, vol-targeting strategies, and many institutional asset managers are near the upper decile of historical equity exposure.

Vol Tends to Rise Into Mid-Terms

Adding to the case that Thursday’s huge rally in names like Bloom, Sandisk, and Coreweave should be faded is that historically, we see market volatility rise into Midterms. Normally, this wouldn’t be enough of a reason to be bearish - but the market is currently extremely dependent on volatility staying low.

Again, any further drop in the S&P 500 or further rise in volatility will lead to AUTOMATIC selling from the CTA and vol-targeting community who are now long in size.

The ‘Technology’ is Different Than the Stocks

The biggest pushback we get when stating that the bubble has popped always comes down to the technology.

“How can you be bearish AI?!”

Remember - the technology and the public equities are 2 different things.

Imagine the argument of a tech bull in 1999. It would go something like this…

“You don’t understand - the internet is going to change the world. The numbers are parabolic. The number of internet users isn’t going to stop rising. There are un-imaginable possibilities for what this technology can do.”

Guess what? They would have been right! And they probably weren’t optimistic enough on just how revolutionary the internet would be. And yet… that didn’t stop the Nasdaq from falling -85% and the vast majority of the internet companies at the time going to ZERO.

Google didn’t go public until a few years after the bubble burst. Facebook didn’t go public until the 2010s. Social media wasn’t even a term in the late 90s.

The point here is this - of course we are ‘bullish’ artificial intelligence as a technology. But that doesn’t mean that who the market currently perceives as the winners will meet these lofty expectations. The world’s largest AI company in 2050 might not even exist yet.

Overall, the market valuations are completely underestimating technological innovation that drastically changes forward earnings assumptions (think memory and hardware improvements). And to add onto that, we just received proof that much of the Q2 run-up was driven by reckless leverage.

The ‘Crude Oil VIX’ (oil’s implied volatility) has significantly diverged from equity volatility (VIX index) in recent weeks.

This weekend was the first time in weeks that the US didn’t attack Iran, so we are likely to see oil prices fall in the near-term. But this chart speaks to a potential sharp mover lower in stocks if oil were to break to new highs.

Why didn’t stocks fall more recently? Well ‘some’ stocks did. But there is very low correlation across the stock market right now. We’ll get back to that point in a bit…

Global Yields New Highs

The conflict in Iran has distracted the financial media from the relentless rise in global bond yields. Bloomberg’s Global sovereign bond index just hit its highest yield since the Global Financial Crisis.

The problem today, as opposed to pre-GFC, is many developed economies are running huge deficits and the interest cost on those bonds is a growing share of national spending. This is namely a problem for the USA, France, and Japan. However, UK, German, Canadian, and Australian yields are all near the highs as well.

Rising yields represent a risk for currencies (namely non-USD currencies) and threaten economic growth as the bond market is ‘doing the tightening’ for the central banks. But just because the USA has the world’s reserve currency, our assets are debatably the most at risk…

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Everyone is Long the USA

The problem for US assets (stocks and bonds) is that foreign capital flooded into the country over the past few decades, and this has especially accelerated over the past 12 months.

Foreign purchases of US equities are up to a record ~$850B over the last 12 months. This is also ~450% above the average recorded during since 2000. Foreign demand for US equities has never been stronger.

Why does this put US assets at risk?

Well, if you are Japan and you are facing pressure from rising yields, but you also already have too weak of a currency (to the point that you have been intervening), there is only 1 way to keep a lid on your long-end yields… repatriate money to buy bonds.

The higher long-end yields go globally, the increased chance Japan and European countries sell their significant holdings of US assets in order to buy their own bond market. This is ALREADY in the works in Japan.

“TOKYO -- Japanese Finance Minister Satsuki Katayama’s comments last week looking for pension funds to invest more in domestic assets have sent ripples through the country’s bond market on speculation that Tokyo aims to support bond prices and counter a surge in interest rates.” - NikkeiAsia

The Hidden Tech Debt Burden

The other branch of tail-risk for US assets is the tremendous hidden-debt and hidden-leverage that have been fueling both stock prices and real world investment.

“ Hidden debt at U.S. tech giants swelled eightfold in roughly four years to an estimated $1.65 trillion as artificial intelligence investments ballooned...
Nikkei examined recent financial statements and other materials from Google owner Alphabet, Microsoft, Amazon, Meta and Oracle. The five companies' hidden debt, which does not appear on balance sheets, totaled $1.65 trillion in the most recent quarter, exceeding the roughly $1.35 trillion in debt reflected on their balance sheets. The data includes some estimates.”

Our point isn’t about the Mag-7 going bankrupt. It is more about leverage behind the scenes. And that very leverage is future revenue across the “capex beneficiary” landscape.

So how do you invest with all these tail-risks, how does one diversify here?

Energy vs. Non-Energy Stock Correlation

Bridgewater is famous for putting a basket of un-correlated assets into 1 portfolio. Classic efficient frontier. This tends to be hard in equity markets because correlations tend to be high across sectors. However, with correlations near all-time lows, the equity market is currently providing you a gift that makes it easier to diversify.

The key is to not look think about sectors or to some extent equity factors. It is to look at correlations. The trailing 1-year daily correlation between S&P 500 Energy and S&P 500 Ex-Energy has turned negative for the first time since the dot-com bubble and reached its most negative level ever.

To diversify away from US equity and tech bubble risk, you want to find ‘un-correlated assets’. For the first time since the dot-com boom, there is loads of un-correlated spaces within the US equity market - with energy being the perfect example.

The stock market is serving this to you on a platter… Buy un-correlated assets!

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After a brief victory lap with quotes from recent notes (if you would like to go back and read them), it’ll be onto the charts for this week.

Cheers!

“We have stocks moving in opposite directions with many defensive names becoming cheap cheap cheap… it is time to buy the “anti-AI” and defensive stocks.” - EasyMarkets, May 29th, “Time to Buy “Anti-AI” Stocks”

“It is not a coincidence the chart of the Nasdaq in the early 2000s looks identical to this chart. Our guess is semiconductors will look the exact same. Friday may have been the beginning of the end for AI-euphoria.” - June 7th, “AI-Euphoria”

“Not only are indexes extremely concentrated, but there is meaningful leverage under the hood.” - June 20th, “Leveraged (Unrealistic) Expectations”

“Momentum stocks (50% of most momentum ETFs are now semi stocks) have seen their all-time high outperformance vs. broad indexes over the past 12 months. Ripe for some mean reversion.” - June 27th, “Tech Talk and a Gold Trade”

Record Momentum Sell-Off

The High-Beta momentum factor just had its worst 5-day performance since COVID.

Retail Favorites Crushed

July is shaping up to be the worst month for Goldman Sachs’ basket of retail favorites since April 2022.

Semis -20%

As we have discussed, semiconductors were at the heart of the momentum trade are now -20% off their recent highs.

Rotation Away From the Winners

Everything that led the market in the first half of the year has been punished. Keep in mind, this chart is now a week old, and the numbers are even more red.

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Nothing Has Changed at the Index Level

Thus far, this has been a rotation out of momentum and into what wasn’t working previously. So amazingly, the divergence between single-stock vol and index (S&P 500) volatility has only grown wider.

Puts are Cheap

Because of this, index puts are historically cheap relative to calls. Everyone is buying protection in single-stocks and specific ETFs or baskets - nobody is buying protection on the S&P 500 as a whole.

Crash protection is essentially free.

Earnings and Job Openings

So, we are ripe for a sizeable spike in volatility and a sizeable drawdown in the S&P 500. All it will take is a macro-level shock to unpin the index.

From this standpoint, we think the most likely culprit will be bond yields rising (of course a Hormuz headline could do it too).

The underlying trend in the past few weeks has been investors too bearish on real world growth. Remember, equities are THE driver of consumption now. They are simply too big relative to the overall economy. Stock gains lead, consumption follows. Corporate profits lead, job growth follows.

Throw in supply constraints from a war in the Middle-East and shortages across the tech supply chain and you have a pretty inflationary tail-risk in the near-term.

We aren’t saying a quick market crash (10%+ drawdown) is ‘likely’. We are just saying the risk/reward of hedging for that event makes a lot of sense.

We like VIX calls.

Over the past 12 months, free cash flow generation of the big-tech companies has plummeted as their Capex budgets have ballooned. The vast majority of this capex has turned into free cash flow for the big semiconductor players.

This is an unsustainable trend and points to downside risk for the chip names.

Why? Micron earnings were “so good” that they proved just how much they are squeezing the big-tech companies. The rise in chip costs forced Apple to raise prices for phones and laptops, and forced Microsoft to raise prices on Xbox’s this week. That won’t make the Trump admin happy. And then on Friday, Apple reportedly was requesting that the White House allow them to buy cheaper Chinese chips.

The big takeaway here is whether its via cheaper Chinese alternatives, political pressure, or via technological innovation - priority #1 for the hyperscalers is how to NOT keep sending all of their money to oligopoly of Micron, SK Hynix, and Samsung.

To be bullish these chips names here is betting against the ingenuity of some of the best CFOs on planet earth.

Momentum Stock Outperformance

While the fundamental picture for semiconductors is at extremes (MU insane 85% margins), the stocks themselves have seen even more extreme price action. Momentum stocks (50% of most momentum ETFs are now semi stocks) have seen their all-time high outperformance vs. broad indexes over the past 12 months.

Ripe for some mean reversion.

USA Net Capital Inflows

Another major supportive factor for US equities has been foreign inflows.

US net capital inflows surged to a record $884B over the past year. Just like the dot-com bubble, you have a colossal amount of outside money is entering US financial markets. Everyone wants in on the AI trade.

While this isn’t a reason to be outright bearish tomorrow, it IS a reason to not buy the dip when the AI capex trade finally reverses lower. Foreign capital inflows have acted as a ‘multiplier’ on the way up - they will be a multiplier on the way back down.

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Leveraged ETF Volumes

Another multiplier is the outright leverage in the system. Volumes of leveraged ETFs have surged in recent months.

From our standpoint, we are trying to be patient. Not chasing the semi names, but not putting on giant short positions just yet. The space looks to be losing momentum, but we are waiting for a bit more support to break.

In the meantime, the best trades are bets somewhat uncorrelated to AI…

Hawkish Fed Speak vs. 1-Year Inflation Swaps

One dynamic that has opened up trade opportunities is the divergence above. With oil having crashed back to pre-Iran war levels, inflation swaps have also crashed. Yet despite the plunge in inflation expectations, most of the FOMC has become increasingly hawkish.

We agree with the market, and not the Fed. We expect dovishness to slowly re-emerge. The trade here is to buy short-end bonds (June 2027 Sofr) and assets that have been beaten-up by the recent jump in the dollar - namely gold.

Chinese Gold Demand

Gold has been crushed and is roughly -25% off its recent highs. Gold’s fall has clearly been due to the rise in the dollar and short-term US interest rates. The major demand sources are only accelerating. Gold imports into Hong Kong surged to ~100,000 kg in April 2026, the highest since December 2023.

We re-entered gold longs on Friday after exiting in early January, we also added some started positions in Ethereum this weekend.

Shorts Semis
Long US short-end bonds
Long Gold
Long crypto (tight stops on the crypto side, the Saylor situation is messy)

Happy 4th. Cheers.

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Over the past quarter century, buybacks and M&A have consistently reduced the supply of publicly listed US equities. That tailwind is slowly turning. SpaceX, Alphabet, Meta, OpenAI, and Anthropic - a group that could together raise roughly $400B. That would exceed typical annual equity issuance by more than 2x. With all the lock-ups becoming available slowly over time, this will extend into 2027. As a result, NET supply is set to move from negative territory to clearly positive.

Ratio: Hyperscaler vs. Semiconductors

While the supply side is clearly a risk to the equity market, the overwhelming amount of Capex (and increase of SPX earnings) has more than compensated for these worries. However, the very companies who are spending all this money are starting to see their stocks not being rewarded by the market. While they have underperformed peers, most Mag-7 equities are quietly down YTD.

Goldman: “The first hyperscaler to signal that it can slow the pace of spending will likely see its share price rewarded. If that happens, others will take notice. That is the reflexivity that ultimately stalls the capex cycle.”

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Big-Tech Free Cash Flow Expectations

Meanwhile, there is extremely optimistic (downright impossible) free cash flow expectations built-into the hyperscalers.

In our view, it is nearly impossible for the 2030 “trillion in capex” to come through AND have big-tech making record free cash flow. The banks are basically saying the each individual LLM will be making trillions in revenues in just a few years.

This is the catch-22 in the market right now. The more optimistic investors become on Capex, the more hyperscaler equities underperform semiconductors and the more the stocks funding economic growth get punished. And the lower MSFT, META, and others trade - the more likely capex plans get revised lower and the cycle turns in the other direction.

Hyperscaler vs. Tokens

Many token-cost indexes are popping up. While there is no ‘perfect’ token cost index, most are beginning to roll-over in recent weeks.

Here lies the other problem with the previously-shown free cash flow estimates. They are pricing a world where “everybody wins”. In reality, there will be price competition to gain users. The trend of technological improvement is toward LOWER prices - especially in a highly competitive environment. To put it simply, if Claude raised their prices from $20/month to $2000/month, everyone would just use Codex. The monetization of this is going to be difficult, not ‘everyone’ can win. And yet - trillions are being spent.

One of these horses is going to throw in the towel soon - a harsh reality confrontation is coming soon.

S&P 500: Funding Cost

And the final piece of the puzzle which points to meaningful downside risk over the next 12 months, is the market structure behind this rally. Not only are indexes extremly concentrated, but there is meaningful leverage under the hood. We have seen an unprecedented surge in S&P funding costs by dealers lending out futures and Total Return Swaps to institutional clients. Think of it as lending costs (via leverage demand) for long positions.

Memories of Archegos…

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The Producer Price Index (PPI) jumped to its highest YoY level in over 3 years this week. Remember, crude oil is an input for many materials. Not to mention restricted supply chains lead to higher costs.

Note the lag from PPI to CPI. Producer Prices bottom in 2020 roughly 6 months before inflation really got going higher, and peaked roughly 6 months before inflation started to roll over.

We will continue to see higher CPI prints for months to come.

Shelter Inflation Turning Higher

Further supporting the argument of higher inflation to come is the fact that shelter disinflation has bottomed. Shelter inflation was up 3.4% YoY in May, after rising 3.3% in April and bottoming at 2.96% in February. Remember, Shelter is a large weighting in the inflation basket calculation.

Real Wage Declines

Rising inflation is just beginning to pressure consumers (all over again). Up until a few months ago, wage growth had been outpacing inflation since early 2024. Now, wage growth is very muted, so real wages (less inflation) are just beginning to roll over.

This is an added weight on the existing K-shaped economy. The lower half of the K will continue to see their financial situation deteriorate.

New Low for Savings Rates

We can already see this playing-out in savings rates that are down to multi-year lows. The lower half of the K is spending from savings and relying on credit cards. The upper half of the K is being supported by rising assets prices.

IPO Season

We have said it many times - at this point the stock market IS the economy. “We are over equitized” as PTJ said a few weeks ago.

Insert equity supply. One of the biggest tail-winds for US equity indexes over the past 15 years was falling equity supply. Stock buybacks were outpacing equity issuance by large margins year after year.

Now we have a string of IPOs (even after SpaceX) and existing companies issuing extra equity namely via converts. While it went under the radar, Google’s $80B equity issuance was nearly the same size of the SpaceX IPO.

More issuance to come.

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Half the S&P is at 10x/Sales

Equity issuance is coming when (parts of) the market is an obvious bubble. Half the US equity index is trading at 10x sales. Not 250 stocks, but rather 51% of the S&P 500’s market cap.

Collapse vs. Rotation

In our view, this cycle is clearly very similar to the dot-com bubble. It is not 2008. The government simply won’t let that a collapse like that occur.

What many miss… From January 1st 1999 to the dot-com peak in mid-March 200, the Nasdaq rose over 130%. Meanwhile, big-boring value stocks in the Dow Jones Industrials average were basically flat in that last leg up.

In the next 12 months after the day tech stocks peaked, the Nasdaq fell -59%. Destroyed.

The Dow Jones Industrial Average in these 12 months? +8%.

Here is what people miss: Unless the world is falling apart, the money tends to rotate to a different place.

We have been vocal “bubble” alarmists on the AI trade.
That doesn’t mean you can’t be long.

Just buy the boring value laggards and the cheap bottlenecks.

Materials as % of S&P 500 Market Cap

Everybody knows semiconductors have been the scare resource in the AI capex trade. Memory costs have surged, stocks are up 10-100x in the space.

However, you don’t have to be long semis here to be “long AI”.

Materials equities have fallen to their lowest share of the S&P 500 in over 35 years. If we are going to build data centers, and more importantly INFRASTRUCTURE to power these data centers, companies need materials. They need electricians, they need wiring and electrical equipment, they need pipelines.

It is time to diversify to boring value stocks and the cheap bottlenecks.

Power infrastructure
Pipeline
Materials

Yes pockets of these areas are expensive, but overall, if estimates of semiconductor forward earnings and hyperscaler capex do actually come to fruition - many of these names are significantly undervalued.

The bottlenecks should continue to work, right now it is semiconductors, next up is real world assets. Remember, the rotations at these extremes can be extremely sharp.

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Non-farm payroll surprised bigly to the upside on Friday. The market and the public are slowing figuring out that the labor market is re-accelerating.

The three-month moving average of payroll gains above shows a cyclical rebound in the labor market.

Earnings Driving Job Adds

A great chart from Jonny Matthews at SuperMacro shows why: the demand for labor is strongly correlated with S&P 500 earnings. Thus far in 2026, we have seen a surge in EPS numbers - the demand for labor is just catching-up.

Consumer Spending by Income Group

Separately, the spending share of the top 10% by income is now much larger than the bottom 80%. Job growth slowed in 2025, but large stock market gains drove spending for those that own assets (the top 10%).

The point here is this: It is nearly impossible for the US economy to go into recession without a falling stock market. In the words of Paul Tudor Jones, “we are too over-equitized as a country”.

The risk here is this is all circular. The demand for labor is tied to earnings, stock prices are tied to earnings, the spending of wealthy cohorts is tied to the stock market. The risk is if stocks fall, spending slows, then earnings fall, and then the demand for labor collapses.

Positive Correlation Stocks and Bonds

This is part of the reason why the correlation between stocks and bonds has surged into positive territory. Lower yields (higher bond prices) means the AI capex build-out can continue and money is cheap. Higher yields (lower bonds prices) are what always has popped asset bubbles.

Said otherwise, the strength of the economy is sowing the seeds of its own demise. The labor market is strengthening as earnings have surged, but stocks need more and more capex to keep going up from here. Both of these are upside pressure on interest rates which are THE risk.

Factor Unwind Friday

The other thing synonymous with asset bubbles is leverage. In recent weeks, people piled into semiconductor names while hedge fund pods were falling over themselves to chase names with earnings momentum. This led factors to get to extreme price levels heading into the week, which created a record factor unwind on Friday.

From our friend - we had the “best day ever for Long/short low vol factor equities vs. Long/short momentum.”

The Path Ahead

When it comes to the path moving forward, we agree with Mike Green. We are the “peak of inflated expectations” when it comes to the benefits (ROI) of all this AI spend.

It is not a coincidence the chart of the Nasdaq in the early 2000s looks identical to this chart. Our guess is semiconductors will look the exact same.

Friday may have been the beginning of the end for AI-euphoria.

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Let’s get right into it…

Total Call Option Value vs. S&P 500 Market Cap

While this chart has largely headed higher due to the overall growth of options, the spike in recent months is clearly tied to the euphoric sentiment in markets.

Just earlier this year, the ratio of total call option values relative to the S&P 500 plunged down to level it saw in 2020... In a few months, we have quadrupled from these lows.

Put / Call Skew

Put / Call skew for single stocks is near all-time lows. Puts are normally much more expensive than calls - not anymore. The stampede into calls is making upside potential nearly as expensive as downside protection.

Emerging Markets Without the Big 3

“AI has clearly helped the US equity market, but look at emerging markets… surely they are rallying on different factors?”
Wrong!

What an amazing chart this is. If you take out the 3 large semiconductors in emerging markets, the sector’s performance relative to the S&P 500 looks entirely different. An astonishing perspective on display here.

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Inflation Inflation Inflation

Dell up 20%! Snowflake up 40%!! The rally in stocks is so amazing it almost makes you forget there is a war going on!

And more importantly, it is in one of the most important ‘real-world-implication’ regions in the world. With the Strait still largely closed, commodity prices are being supported.

The rise in gas prices has led to a rise in airlines prices.

Inflation inflation inflation… it is just getting started.

Bonds are Imploding

And right on cue we have a slow-motion train wreck on display. It is pretty amazing the sovereign bond BUBBLE burst in 2020 and few point it out. Yes everyone knows bonds have struggled, but if one just zooms out - it is pretty clear to see the trend. This is a secular decline.

We have a global race to build datacenters, a global race to re-build defense capabilities in a hostile world, restricted commodity supply, increasing consumers costs, every single country and their mother running deficits… of course bonds yields should be higher!

And more importantly, if there is a “prick” to the AI bubble… like it has been throughout the history of capitalism… it is likely rising interest rates.

Correlation at the Lows

Ok so we have the correlation of S&P 500 stocks at just about all-time lows. But the important thing to remember is low correlation doesn’t mean things are moving ‘independently’. This usually means many stocks are moving opposite of one another.

Just like the dot-com bubble, people are fleeing low-volatility and defensive equities for high growth and high momentum stocks. It is obvious on a daily basis. Semiconductors up, AI-capex stocks up, software (seen to be disrupted) down, defensive consumer staple stock down.

How do you short a bubble? You don’t short the high-flying equities that can double in your face! Instead, just like the dot-com boom, you start to accumulate the “opposite side of the coin”. The Anti-AI trade.

Everybody Hates Defensive Stocks

Many consumer staples, boring slow-moving dividend stocks, and healthcare names have been destroyed. Healthcare equities have shrunk to their smallest percentage of the overall equity index since the early 2000s!

We have an options frenzy going on with everyone piling into calls

We have a giant risk of upcoming IPOs coupled with rising interest rates ready to pop the bubble

We have stocks moving in opposite directions with many defensive names becoming cheap cheap cheap.

The way to play this is not to short Nvidia… it is time to buy the “anti-AI” and defensive stocks.

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While stocks are surging on AI-capex numbers, bonds are rolling-over with inflation beginning to re-accelerate. This has sent the ratio of stocks to bonds surging higher with the weekly RSI now its highest level in over 20 years!

Dispersion Under the Hood

Within the S&P 500, it has not been an even rally. Many consumer-cyclicals have been bleeding lower for months, while Semiconductors have been moon-shotting to the upside.

Semiconductors Very Extended

The rally in Semis is extremely over-heated in the near-term. Semiconductor stocks are now trading 63% above their 200-day moving average, the largest spread since the Dot Com Bubble.

Semis Eating Tech

Keep in mind, it is not growth stocks doing well as a whole. Software, of course, has seen significant selling since October of last year. The S&P 500 semiconductor industry now accounts for a record 41.9% of the total market cap of the information technology sector. Semis are eating everything - even other tech stocks.

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Momentum vs. Min Vol

Overall, the move has been less about fundamentals and more about factors. Momentum equities are surging, Min-vol is getting crushed. This speaks to hedge funds pods and algorithmic flows widely exacerbating what the rally “should” have been.

HealthCare and Defensives Falling

Also reminiscent of the dot-com bubble is the fact that defensives (Staples, healthcare, etc) are getting sold hard. Minimum Volatility factor equities are getting destroyed relative to grow. Health Care’s weighting in the S&P 500 has fallen to 8.3%, its lowest level since 1994!

Hidenburg Signal

From a trading standpoint, it may be time to take a short on betting against these extremes.

Yields Breaking-Out

Throughout history, there has been one common factor that tends to pop risk-asset bubbles… rising interest rates.

Last week, US yields broke-out to the upside after a handful of week auctions and pretty worrisome inflation data.

UK 30s New Highs

Importantly, the US yield breakout higher is now about “strong data”. It is happening right along with every other developed economies’ long-end yield breaking higher. The UK faces added pressure with a changing of Prime Minister on the way, but this is a global story.

Japan, Germany, US, UK, Canada, and more… they are all seeing yields at the highs of the past decade.

What the long-end - if the bubble is going to pop, it is because yields continue to rip higher.

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On the surface, you have seen upward revisions to earnings estimates, upbeat manufacturing data, healthy transportation volumes, and a surging stock market. The data says we are in a cyclical upswing. While this is ‘true’, underneath the hood it is AI and only AI, all the way down.

Computer Equipment Investment as % of GDP

AI Capex, accelerated by the Big Beautiful Bill, has led computer equipment investment to surge to 1.2% of GDP.

EPS Growth is All Tech and Energy

Thus far in 2026, we have seen significant upward revisions to earnings and revenue expectations. It is all tech. Outside of energy, (which of course has benefitted from the spike in oil prices) the tech sector has been responsible for the vast majority of the increase in earnings expectations and nearly entirely responsible for the increase in revenue expectations.

EPS Revisions by Sector

Furthermore, if we look at the change in global EPS expectations by sector - the majority of sectors are actually seeing declines! Look at the cyclical, real world economic sectors. Consumer discretionary? Largest decliner. Real Estate? Declines. Consumer staples? Declines. Even communication services and financials are basically flat.

AI-Related Imports vs. Non-AI Related Imports

AI investment is quite literally earing the world. While the growth rate of AI-related imports into the US has surged this year, the growth rate of non-AI-related imports is cratering at 2008-like deterioration levels.

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Hedge Fund Piling into Semis

The problem for investors is this looks largely “priced-in” at these levels. Hedge fund semiconductor exposure has spiked higher in the past few months, while they have liquidated software names who are seen to be at disruption risk from AI.

Systematic Flows Driving the Rally

As we predicted in the first week of April, non-discretionary flows have added fuel to the fire. In the past month we have seen a record amount of non-discretionary inflows, supported by an estimated $251 billion in forced buying from 401(k) flows and systematic strategies, per Tier1Alpha.

Weak Breadth in the Rally

Despite all the non-discretionary flows, which presumably are going into broad-indexes, there has been very weak breadth. To put it simply, AI names are driving the index and anything not related to AI capex is underperforming.

The percentage of S&P 500 stocks outperforming the index over a rolling 21-day period fell to 21% last week. Since 1928, there have been only 59 other instances with weaker participation.

AI is Eating the World

In the foreseeable future, it is difficult to see how this trend changes. The conflict in Hormuz will only pressure US consumers (especially the bottom half of the ‘K’) further. Meanwhile, the Trump administration is doing everything they can to keep interest rates down, which just prevents a potential headwind.

To us, this points to a further “eating of the world”. AI technology will continue to advance, the ‘race’ of Capex spending will continue until the market tells CEOs it is a bad idea.

To that point, there is 1 major risk for these equities….

A Tsunami of Supply

Part of the reason we have been in such a structural bull market is because of the supply/demand picture. Corporations have bought back shares in size, while there has been very little supply (IPOs). The one year we got a surge in equity supply was followed by a bear market in 2022.

Not only going a ton of equity supply already likely, but this number could spike further if Anthropic, SpaceX, or OpenAI announce IPOs.

It was no coincidence that this was just how the dot-com bubble finally popped.

At the end of the day, financial markets can be reduced down to 1 thing… supply vs. demand!

Keep an eye on the IPO announcements, we could see trillions of supply by year-end.

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Ai stocks continue to dominate the equity market. They barely took a breather, while everything else puked in late March. Specifically, AI-infrastructure related names (think electric grid and semiconductors) continue to go vertical.

Record Run for Semis

This has led to a record run in semiconductor equities. The sector has smashed through previous records and has now rallied 18 (!!) consecutive days. Truly historic.

Earnings Expectations on the Rise

Part of the reason why broad indexes have rebounded so fast (other than the flow which we have highlighted in recent notes) is because earnings expectations are surging. Beneath the hood, AI related names (AI infrastructure especially) are a huuuuge amount of this expected EPS increase.

The problem is that this has all the signs of a classic cyclical boom and bust. The simple fact many are choosing to ignore is that semiconductors are historically one of the most cyclical sub-sectors of the economy! This is a space that reliably, almost un-avoidably, has through mini-to-large boom and bust cycles.

The Semiconductor Bubble

The semiconductor sector is currently exhibiting classic “late-cycle” behavior that mirrors the lead-up to the 2000 crash. We are seeing major players engage in aggressive double and triple ordering. It is a frantic attempt to front-run an anticipated supply chain breakdown.

This hoarding mentality creates a deceptive “phantom demand” that artificially inflates bookings. Much like the post-COVID era, this over-ordering is a precursor to a significant inventory correction. When the perceived scarcity vanishes and the supply chain stabilizes, the industry will likely face a sharp contraction as these excess orders are canceled, signaling a major downturn for the sector from current levels. Looking at a simple chart of DRAM and NAND prices over time shows this has occurred over and over again. Dot-com cycle, early 2010 smart phone cycle, mid 2010 video game driven cycle, early 2020 crypto mining driven cycle. The current cycle is the largest of them all.

Key Cycle Dynamics:
1. Panic Hoarding: Buyers over-ordering to hedge against supply fragility.
2. Artificial Backlogs: Bookings that don’t reflect actual end-market consumption.
3. Mean Reversion: A shift from shortage to glut that historically precedes a sector-wide collapse.

Disclaimer: We are not saying this bubble pops tomorrow. Timing when chips prices rollover is nearly impossible in advance.

Sentiment vs. Stocks

Another major headwind for the space is a political one. Think about the fact that consumer sentiment is at all-time lows, while equity prices are at all-time highs. This has never happened before.

This very chart is the reason why populism is not stopping anytime soon. Now think about AI as the most labor-displacing technology we have ever created. The idea that this technology can continue to exponentially grow with full encouragement from the general public is plain wrong. Will 2026 earnings expectations be met? Probably much of the demand is orders in advance as we highlighted.

Will all the sky-high 2030 estimates for the industry be hit? Zero chance.

The reason is not technological, but societal. Nobody is thinking about what further exponential growth means for society. And nevermind labor, a significant chunk of the US economy is tied to software that is facing disruption.

The simple fact is the US economy and the US stock market is now an “Ouroboros”. A snake eating its own tail. AI cannot continue to grow at the current speed without massive pain for existing software businesses, white collar jobs, and society as a whole.

Diversified Portfolios Are Leading

While timing the peak is difficult - the easiest thing an investor can do today is simply diversify. As we have discussed for 2 years now, the 60/40 portfolio is dead.

Meanwhile, a very diversified portfolio of 25% stocks, bonds, commodities, and cash is off to its best start to the year since 1933.

Diversify - there is volatility ahead.

Technology sector equities ripped 20% over the last 13 trading days, ending last Friday. The last two times it was up more were coming out of Covid and the Financial Crisis (March 2009).

CTAs Bought in Size

As expected, CTAs bought more than $86Bn in equities over the past five sessions - one of the biggest buying sprees on record. We highlighted last week why there was a positive snowball of flows…

“These wild swings continue to happen because of mechanical and predictable flows. CTAs (algorithmic trend followers) got very short equities as the market grinded lower and then were forced (via their own algorithms) to rebuy as the market rebounded, adding fuel to the fire. Vol control funds, CTAs, retail… the rebounds from the lows become a snowball of positive flows.” - Easy Markets, OpEx Complacency

Put/Call Ratio

Also expected - the put/call ratio plummeted into last week’s monthly options expiration (OpEx) as upside call strikes that were sold in late March were pushed through. This coincided with huge outperformance from high short interest names (check out Avis stock).

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Record Call Volume

We also had a record amount of call volume relative to puts last week. To us, that does not point to a fundamental bullishness, rather a classic gamma squeeze.

“This rally will continue until at least VIX-peration (Wednesday morning) and potentially Friday morning (OpEx), and maaaybe the Friday close.”

Well now that we got the “OpEx complacency” squeeze we were looking for - where do we go from here?

From our viewpoint, this is “judgement week”.

Either the market begins to sell-off on the reality that has not changed (no oil flowing through the Strait) or the market is simply confident the reality will ‘catch-up’ to current prices.

Weak Breadth at New Highs

Per 3fourteen, last Thursday’s all-time high occurred with only 2.4% of S&P 500 stocks making a 52-week high. Out of 792 days where the index made a new 52-week high since 1998, this is the fewest number of stocks participating.

Once again, this backs-up the view that the rally is not ‘healthy’. Not only has it been driven by algorithmic flows (CTAs and options dealers) but the leaders are really just AI-related names.

Price vs. Sentiment

We got heavily short right before the close on Friday. Today’s price action was surprisingly dull given the 6% oil pop, but the market clearly has its eyes set on planned negotiations that may or may not happen this week.

We are in the camp that the ‘reality’ disappoints and markets have gone too far too fast. We are holding our shorts while being cognizant that this is really a short-term trade.

The problem with a longer-term trade is sentiment (above) has not re-priced as we expected. To put it simply, everyone is still bearish. This is one of the largest price divergences vs. sentiment we have seen.

While we are in the business of making longer-term calls, this is simply not the type of market where you pile into a longer-term thesis. AI and capex build-out names are already making new highs, beaten-up high short-interest names have surged, we view this as a time to be patient and tactical.

We are holding-out for what we view as a fork in the road for the near-term. “Judgement week”. If we are wrong about markets in the coming days, we can always reassess a few percentage points higher with the worst behind us. But for now we are:
- Tactically short Nasdaq Futures
- Long agriculture commodities
- Short long-end Treasuries
- Long Vol (VIX calls)

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The market has gone from meaningfully oversold to meaningfully overbought in just 2 weeks. Wild swings!

A Mechanical Squeeze

However, the V-bottom in equities should not be extremely surprising. These wild swings continue to happen because of mechanical and predictable flows.

CTAs (algorithmic trend followers) got very short equities as the market grinded lower and then were forced (via their own algorithms) to rebuy as the market rebounded, adding fuel to the fire. Vol control funds, CTAs, retail… the rebounds from the lows become a snowball of positive flows.

US Outperforming Everything

Relative to their pre-conflict peak, US equities have retraced way more than every other asset class. To us, this is proof that the current rally has gone well beyond “fundamentals” - the recent buying has been algos that do not care about the current state of affairs in Iran.

The Current State of Oil Markets

While US equities have rallied 8 consecutive trading days in a row - the reality oil passing through the Strait…. hasn’t changed.

Further proving this market vs. reality dynamic is the spread between real-world vs. paper oil markets which are now at a record spread.

The point here is this - the US equity market and now the oil market itself (front-month) are making a giant gamble that this conflict is over within the next 2 weeks. Anything longer, is going to send shock waves.

Blockade Math

The blockade dip has already been bought, but the math is concerning. This is a class economist view of where oil should trade - we don’t agree with the numbers. That being said, it is a helpful framework. The US blockade just reduces daily supply further. Again, that is fine if you expect oil to be flowing soon, but the market is clearly under-estimating Iran’s willingness to take pain and not concede. At roughly 8-10mb/d now out of the Gulf $150 is a very real possibility.

CHINA INDICATED IT WILL HALT EXPORTS OF SULFURIC ACID FROM MAY

The other giant bet the market is making right now is that there is no further escalation. Here is the problem - the longer this drags out, the more pushback you get from countries that are suffering (namely China).

A sulfuric acid export halt. That is one very specific commodity from one specific country. That commodity just so happens to also be a key input for agriculture products and thus food prices. Again, if tensions rise, the problems accelerate like a ramp, they are not linear.

There is 2 directional possibilities from here:
1. We are wrong, oil starts flowing through the Strait soon, the market has been “fundamentally correct” and continues to rally and future inflation never arrives in a significant manner

2. This rally was not driven by fundamentals, rather mechanical flows the exacerbated a rally after minor good news. We are now at the point that the risks in reality are being significantly underpriced. Not only is the risk to large oil upside in the near-term growing by the hour, but the market is overlooking the inflationary ripple effects that are likely to come in agriculture and other commodities.

We are in camp #2.

This rally will continue until at least VIX-peration (Wednesday morning) and potentially Friday morning (OpEx), and maaaybe the Friday close. If the reality of oil flowing through the Strait does not change in the coming days, we are going to peak and RAPIDLY fall lower.

Maybe we are underestimating Trump, but right now this looks like February 2020’s OpEx complacency.

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Markets are ripping, oil is plunging, and the worst may be over. Emphasis on the ‘may’… The US and Iran have agreed to a 2-week ceasefire. But don’t get too focused on the 2-week timeframe. The 2025 tariff saga taught us the deadline can always be pushed back (to the benefit of equity markets). The question is can it hold.

The surprising part of this? Trump basically just conceded control of the Strait to Iran in order to save the market. Full stop.

Will the US try to have them “loosen” that control during negotiations? Of course! But for now, Trump has walked-back pressure.

Traffic in the Strait

To be clear, thus far there has been virtually zero passage through the Strait since the ceasefire announcement - but this isn’t all too surprising. Insurance, communication to lower-end IGRC squads, shipper confidence, all this will likely take a day or so. The other problem is that Israel clearly did not agree to the terms of the ceasefire beforehand and continue to attack Lebanon. We are close to a make-or-break moment.

The other giant question that must be answered - will the ships that inevitably pass through the Strait this week need to pay Iran a toll of $2 million (half will supposedly go to Oman)? If so, and it looks to be the case thus far, this means the supply of oil will not be “returning to normal” anytime soon.

Volumes in the Strait

Volumes were beginning to creep back up as ships were going through the Iran toll booth last week.

If you go back and read the Iran quote in the post from Trump himself, the key portion is “For a period of two weeks, safe passage through the Strait of Hormuz will be possible, via coordination with Iran’s armed forces…”

Again, giving emboldening Iran to ‘coordinate’ the passage of the Strait of Hormuz is bullish for oil in the longer-term. This set-up would serve as a constant friction on supply, especially in the coming months if “negotiations” are ongoing.

Everybody Long Puts

While normally we would go out and fade this move in size, the problem for equity shorts (us included) is retail started to pile into puts in the last 2 weeks. The problem is this adds fuel to the upwards rally as everyone rushes to get back into the market. This is very very similar to April of last year. And the higher the market goes, the more people get brought in, and the smaller chance you revisit the lows. We are leaning towards this ceasefire being “fake-news”, but that will depend on if Trump can gets the “kids” (Israel and Iran) to stop fighting.

Oil vs. Inflation

Make no mistake, despite the conflict being over for the time being and no matter what the S&P 500 does in the next few weeks, inflation is heading higher. There will be meaningful real world consequences seen in the coming few months. The key question is what does longer-dated (December) oil do in the next few weeks. For now, it is not crashing like the front month, and higher oil means higher commodity prices and higher inflation.

A Trip Back to 1973

Assuming US military conflict in the region is behind us, Central bank reaction function is important to watch moving forward. Back in the 1970s, after the 1973 Yom Kippr war, the Fed was forced to hike as the market grinded lower. This was partly because the KICK-STARTED an inflationary surge. This is why inflation and potential rate hikes are so important.

For now, we sit in the camp that the Fed will treat this like Covid or tariffs… just another “one time price adjustment” which they can look through… no rate recessions allowed!

From an investment standpoint this makes us like weak dollar plays moving forward - though we may need the dust to settle in the coming few days before piling-in. We are likely going to initiate positions in: Copper, emerging market equities, global defense stocks, solar stocks, and inflation benefitting equities if they sell-off.

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Let’s start off high level… Every US recession excluding the pandemic downturn was preceded by an oil price shock. The conflict in Iran is a potential cycle ender.

Stagflation is THE Risk

This is a great chart from Kantro (Strategist at Piper, i.e Cornerstone) - The exact levels are not what is important here. The larger point is that inflation is a risk - and stagflation is the big risk. The longer the Strait of Hormuz is closed, the higher the probability of stagflation is.

Protecting the Right Tail

Somebody on Twitter made the chart above and jokingly said “I think I solved the stock market, all you need to own is tech and energy”.

The funny thing is they are directionally correct. In a world of elevated geopolitical risk (think the 1970s) what is important is not protecting the left tail of deflation (by owning bonds) but by protecting the RIGHT tail of inflation (via gold and energy). Too many people are stuck in the last decade. As we have been repeatedly writing about for over 2 years, the 60/40 is dead.

Everybody is Hedged

Ok now let’s talk about trading this. The problem is everybody knows the risks. Hedge fund L/S managers are the least levered in the past 15 years. Everybody is buying puts. Everybody is reading the developments in the Middle East. Everybody now knows what Urea futures are.

All this ‘knowledge’ and awareness means you are far more likely to get a choppy slow grind lower (we wrote about this a month ago and thus far it has been dead on).

CTA Positioning

We started writing this note on Monday but couldn’t get it out in time. The theme was going to be ‘watch out for a short squeeze’. Now that it is underway, the squeeze might have some legs, but we have already closed the short-term calls we added.

Now comes for looking for a re-entry on our shorts. But we are going to be patient, some of the 2022 counter-trend rallies retraced upwards of 50%-75% of the previous drawdown.

Bear Market Rallies

For now, we are in the camp of this being a cycle-ending bear market. If the Strait re-opens in the next week, we’ll cave on that thesis. But that is unlikely.

So instead, the game plan is the same as we have laid-out throughout the last few weeks. Lean short. But be tactical as possible. Most of the largest rallies in history have come in bear markets. Tuesday’s surge is likely the first of many this year.

We are back to neutral (slightly long random long-term names we like) but are looking to get back short. 6700 on ES is where it gets interesting.

Remember - the repeat of 2022 is in the early innings as long as the Strait is closed. This could be a cycle ender, but everybody knows that. And in the words of Ben Hunt - when “everybody knows that everybody knows” it changes the dynamic entirely.

Expect chop. The VIX isn’t going to 70. Retail is likely to be sliced to pieces this year. This is a veteran trader’s market.

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The long-only community finally woke up to how big of a risk Iran is. Long-only funds sold -$9.6 billion in US stocks during Thursday morning's sell-off, the largest amount on record.

ETF Flows in the Red

Meanwhile, the SPY S&P 500 ETF and the QQQ Nasdaq 100 ETF have seen combined outflows of -$64 billion over the last 3 months, also the most on record.

Rate cuts are being taken off the table in the US, rate hikes are being put on the table in most non-US developed markets, and oil continues to grind higher.

Record Surge in Oil

The historical context here is very important. This is an extremely rare oil spike. The important thing here is oil prices could slowly fall -20% from today’s levels and there would STILL be a huge inflationary impact.

Bonds Offer No Protection

Welcome back to 2022. As many learned a few years ago, bonds only hedge stocks in a world of record-low inflation. The negative correlation everyone became used to in the 2000s was an ANOMALY with a century long view.

Where Do We Go From Here?

The set-up is very similar to 2022: Rising energy costs are pushing yields curves higher, and those rising yields are weighing on risk assets.

The set-up is also similar to 2022 in that everybody knows the downside risks and are positioned for it. Many hedges were bought throughout the last few weeks.

Go look at 2022’s price action in the S&P 500. What we saw was consistent grind lower for a few weeks and then significant rapid short-squeezes. Rinse, repeat. It was a downward pointing CHOP-fest.

While we continue to be bearish with a long-term view, if we see 1-2 more big red days, it is time to start thinking about TACTICAL LONGS. Short-term calls. The VIX isn’t going to 80. Everyone is “too prepared”. Risks are skewed to the downside with a 3-6 month view, but watch out for sizeable bullish reversals in risk assets.

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Let’s run through the reasons it looks like the clock is about to strike midnight on this cycle.

Jet Fuel Prices in Europe

Fuel prices are surging globally. Global average jet fuel prices just rose +82.8% MoM. Economies that import most of their energy, namely Europe and most of Asia, are especially hurt by the spike in oil prices. And to no surprise, the ECB is now expected to HIKE rates twice by year-end.

US Diesel Price Surge

Just because the US is now world’s largest energy exporter - does not make us immune from the impact of rising prices. Diesel fuel prices are the lifeblood of freight, agriculture, and construction. At above $5/gallon there is high likelihood of inflation to come in the US.

The Fed “looking past” a supply-side shock, doesn’t mean they will cut rates.

Flatbed Rejection Rates in the US

Keep in mind, US flatbed rejection rates (trucking cost) were already surging BEFORE we attacked Iran.

There were some industry specific drivers here with some transportation/trucking companies going bankrupt in 2025, but this is also a function of immigration policy. Less supply of labor. If you are a trucker right now, you are asking for a raise.

The point here is this - we already had building inflationary pressure in the system before Iran. The recent events just pour gasoline on the fire (pun intended).

SPY ETF Volume

With rate cuts being taken off the table and oil prices rising, everybody has shifted defensive. So much defensive that you now have the wealth management twitter icons talking about record put buying and record hedge fund equity sales.

Ya… that’s what happens when a war breaks out. If you think we are anywhere near long-term capitulation (nevermind a lack of short-term capitulation shown above) - you do not understand how the end of a cycle works.

Margin Debt / GDP

Margin debt at the end of 2025 was $1.23 trillion. We are nowhere near long-term capitulation.

This also speaks to how sensitive the real economy is to stock prices. Moreso than at any point in US economic history.

This is why oil prices rising is so important. It’s not about what the price of gas will be next week. It is about the fact that we are at the tail-end of a growth cycle, with the consumer beginning to roll-over, with stock prices beginning to roll-over, with the economies sensitivity to a bear market having near been higher, and the Fed just got put INTO A BOX.

You sell into strength here. Plain and simple. The risk/reward in markets in the next 6 months is the equivalent of getting sushi at an airport.

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