Cracks in the Foundation

The raging bull is showing signs of cracking.  The momentum names are the key to this market.  They are what drive the animal spirits which brings in the inflows in a virtuous cycle that keep the bull market going.  The cracks are forming in AI and crypto, the two drivers of the momentum train.  In AI, the biggest ripple has been made by PLTR, which went from 190 on August 12 to 143 on August 20.  That's a 25% haircut in 6 trading days.  While the SPX went down less than 2% during that time.  Compare that to the dip in July 31/Aug 1, when the SPX went down 3%, yet PLTR didn't even go down 5%.  The momentum names were extremely strong during that dip 3 weeks ago.  Its a totally different story now.  The strongest YTD stocks performed the worst during last week's selloff.

In crypto, you can see a similar pattern of relative weakness during this pullback vs the July 31-Aug 1 dip.  When the SPX went down 3% in that dip, bitcoin went down 5%.  In last week's pullback, SPX dipped 2% yet bitcoin went down 9%.  Relative weakness in bitcoin vs. earlier in the summer.  Also, the most important stock for bitcoin is MSTR.  Its premium to NAV is shrinking steadily.  The money suck coming from big crypto IPOs like CRCL and BLSH, and crypto treasury companies selling stock to buy cryptos is slowly sopping up a lot of risk capital that would otherwise go to other momo favorites.  

These are the subtle signs of a weakening bull, when the momentum names are no longer leading and are getting punished on dips.  You can rationalize these moves as being driven by news such as Citron Research's short report on PLTR, which wasn't anything revolutionary (just a dig at the absurb valuation of PLTR compared to another overvalued company, Open AI).  Or META talking down future AI hiring plans.  These aren't significant news drivers, yet they caused quite a bit of damage to PLTR, META, and NVDA.  Those 3 names, probably the 3 most popular AI names out there in the US stock market have all underperformed during this pullback vs the sharper pullback on August 1.  

Another difference is the length of the pullback starting from August opex.  It was a 5 day pullback that was slow and grinding, not a sudden fear induced selloff that quickly recovered like August 1.  A technical sign of saturation.  Also, put/call ratios were quite low for the first 3 days of the pullback, before finally getting to a bit more elevated levels last Wednesday and Thursday.  If you look at the big picture, the cash holdings at equity mutual funds are very low.  There is almost no dry powder among mutual funds, and very little dry powder at hedge funds who also have above average net exposure vs. history.  

Last Friday, we got the much awaited Powell Jackson Hole speech.  Going into the speech, I noticed quite a few "experts" on CNBC, Bloomberg, Twitter talking about how hawkish Powell will be at Jackson Hole.  It probably explains the slow drip selloff going into the big event.  Expectations for Powell were low, so when he did tee up a September cut with some job market weakness excuses, it launched off a FOMO rocket.  Those fund managers who wanted to lighten up on longs did so ahead of J-Hole, which caused them to panic back into their longs when they realized that this rally wasn't done.  They have to keep up.  Its not a choice.  Its a career decision.   

Long term, whether Powell is dovish or hawkish doesn't matter.  The Fed is no longer the driver of markets.  The econ nerds will always focus on the Fed, but economists don't move markets, investors do.  The Fed can move the markets for a day or two, but they don't move it for months and years like they did in the monetary dominance era.  

We are now in a new era of fiscal dominance, where fiscal policy drives the market, not monetary policy.  Monetary policy becomes toothless when lowering rates actually lowers interest income for the private sector (due to the huge national debt levels, high percentage of T-bill issuance) more than it reduces interest expense for them.  The mortgage refi channel via lower long end rates is broken, as the long end has stubbornly stayed high during this cutting cycle.  In addition, most home owners are already locked in to mortgage rates much lower than current levels, greatly reducing refi demand even if long end rates go lower.  Only if/when the Fed does QE will that have a meaningful effect on the stock market.  That may come sometime in 2026 after Trump installs a dovish puppet as Fed chair.  

Over the past 2 weeks, as momentum has weakened, the Russell 2000 has instead strengthened.  On Friday, while SPX went up 1.5%, the RUT went up 3.9%.  We haven't seen that kind of RUT outperformance in a while.  It is eerily reminiscent of July 2024, right before the SPX had a 10% pullback and a vicious VIX spike over 50.  I do not expect that to happen this time around, but I expect a similar bearish response to RUT outperformance over Nasdaq.  

Before 2022, Russell 2000 underperformance vs SPX and NDX during a rally was a warning sign of a pending correction (2014, 2015, 2018, 2019, 2021).  That was why so many investors became obsessed with breadth as a indicator of the health of the market.  Everyone thought strong breadth is a good sign for the stock market.  Since 2022, as we've entered the fiscal dominance/higher rate regime, Russell 2000 outperformance vs SPX and NDX was a sign of short covering/excessive optimism, proving to be an urgent warning sign that a correction was coming.  You saw this in July 2024, before a sharp 10% correction, and December 2024, before a sharp 5% correction.  And it appears that is happening again in August 2025.  

IWM:QQQ price ratio

No significant changes in the SPX COT data.  The VIX positioning is getting more interesting.  Commercial traders keeping adding to an already big VIX long position, meaning speculators are getting short VIX.  This has happened ahead of some explosive moves higher in VIX in recent years, such as November 2021, August 2022, July 2024, and February 2025.  

COT VIX Positions

The big event of the week is NVDA earnings.  Its a quiet week where many are on vacation, and already squared up without much desire to put on big positions.  There appears to be a bit of caution ahead of NVDA earnings, more than last time, due to some recent headlines and relative AI weakness, but that's offset by most people's expectations that they will beat earnings and pump their stock like they always do.  So expecting NVDA earnings to be a nothing burger.  With the cracks in momentum, the sudden outperformance in Russell 2000, and upcoming seasonal weakness, the odds are now favorable for the shorts.  Will be looking to put on shorts in SPX and individual stocks this week.  Looking for a big down move that could last several weeks in September/October.

Don't Look Down

It feels invincible. The pullbacks are brief, and the rallies keep going.  

It's a nightmare for the bears.  Yet, you still have a large group of investors that are worried about weak seasonality until September.   A recent AAII investor survey showed a huge increase in the number of bears and drop in number of bulls, showing the skepticism out there.   Shorts have gotten punished since the April bottom, with heavily shorted stocks rallying much more than the SPX.  Those who have focused on fundamentals have been left behind.  The most speculative stocks have massively outperformed the SPX.  

At the same time, the CTAs have gone from short to near max long.  A look at the trend following ETF, DBMF shows how things have changed over the past 4 months.  From net short S&P 500 futures in April to massively net long, the biggest long position in their portfolio now.  

DBMF Holdings August 15, 2025

DBMF April 8, 2025

CTA exposure to US equities is now in the 97% percentile historically.  

When you have systematics basically max long, with no more room to add, and plenty of room to sell, a selloff from here will be self-reinforcing and could get nasty.  Add to that the retail investor, who is super bullish and aggressively buying calls vs puts.  

One of the best indicators of speculative fever is cryptos.  The ETF market share of cryptocurrency ETFs is rocketing higher.  There is much broader crypto participation in 2025 than in 2021.  Bitcoin went from $68,700 to $15,700 after it topped in 2021.  There are a lot more assets in bitcoin which is a eye of the beholder zero yielding asset like gold, but without the history, jewelry demand, and central bank purchases.  These crypto ETF inflows + crypto treasuries sprouting up like weeds is another sign of the size of this bubble.  Just last week, a crypto stock called Bullish (BLSH) IPOed and sports a market cap of over $10 billion.  The Wall St operators are rushing in to feed the ducks who are quacking over crypto.  We all know how this ends.  This year's momentum buyers will be next year's bag holders.  

We are seeing a growing divergence between large cap and small cap tech stocks, which is 2000-esque.  So many things in 2025 are rhyming with 2000, its eerie.  

One would understand all this speculative euphoria if the economy was hot and jobs were plentiful.  But what's so unusual about this rally is that its happening as the US economy is weakening, with inflation sticky, and a fiscal drag in tariffs coming down the pike.  Its a financial nihilism rally, based on numbers go up and FOMO.  Signs point to a weakening jobs market in the coming months.  University of Michigan survey respondents are worried about the job market, and they are usually correct.  

You are seeing weak demand for C&I loans, according to bank senior officers.  

This is a dangerous market.  This uptrend is breeding a false sense of security.  These type of bubble markets end with a bang.  The first move down will be savage.  The first move down off the March 2000 bubble top was a waterfall decline of 13%, the first move down off the January 2022 bubble top was a waterfall decline of 14%.   But, you can't be too early, especially if buying short term puts.  The downside is big, and the move likely to happen fast, but you need to make a top first.  I am still not seeing enough call buying given how strong this market is.  

We released quite a bit of potential downside energy on that decline into August 1, which could fuel the rally into the end of the month.  I expect Powell to not be hawkish at Jackson Hole, as he will probably lay the foundations for a September rate cut, which is mostly priced in.  That probably gets bulls excited going into month end and NVDA earnings, where I may look to put on a longer term short position into strength.  Watching and waiting, but the time to strike on the short side is getting closer.

The Mental Game of Trading

Having an edge is the most important aspect of trading.  After that comes the mental game.  The mental game is an underrated aspect of trading.  This assumes that the trader has a long term edge.  If you don't have an edge, the mental game only prolongs the downward drift.  Important aspects of the mental game:  Discipline, Patience, Aggression, Risk Tolerance, Hope.  

Discipline

 “How did you go bankrupt?” Bill asked. “Two ways,” Mike said. “Gradually and then suddenly." - Ernest Hemingway, The Sun Also Rises

The most important piece of the mental game.  In order to maximize lifetime gains, getting to the long run is the most important part.  The law of compounding is often mentioned in investing but usually ignored in trading.  Trading is just investing in shorter term time frames repeated over and over.  Long term investors usually avoid leverage, which allows them to survive and get to the long run.  Traders often use leverage which introduces blow up risk and prevents many from getting into the long run.  

Having discipline to not bet too big.  To not have FOMO and chase.  To not try to catch up and recover quickly (part of : to not bet too big).  Sizing positions correctly to avoid blowing up.  Just as in life, survival is the foundation.  

Patience

"You can beat a horse race, but you can't beat the races." - Jesse Livermore, Reminiscences of a Stock Operator

Traders are always watching the market.  That's like a gambler always watching the action in a casino.  It's tempting to put on trades.  Maintaining the same standards/requirements for entering trades is part of being patient.  A key aspect of patience is also recognizing when a market is good for your strategy and market bias.  A bearish biased trader needs to be pickier and more patient during a bull market and a strong uptrend.  A bullish biased traders needs to be pickier and more patient during a bear market.  For mean reversion traders, being more patient in markets with strong trends, for trend traders being more patient in range bound markets.  

Aggression

"It takes courage to be a pig." - George Soros / Stanley Druckenmiller

There will certain times when your strategy or style of trading will be well suited for the market environment.  You will notice this when you have many consecutive winners or a few big wins.  Its during these times that aggression improves performance.  Being more aggressive in entering trades.  Giving trades more time to reach their destination.  Having more aggressive price targets.  These are the times to follow the cliche: let winners run.  

Risk Tolerance

J. P. Morgan once had a friend who was so worried about his stock holdings that he could not sleep at night. The friend asked, “What should I do about my stocks?” Morgan replied, “Sell down to the sleeping point.” - J.P. Morgan

Know your limitations.  Not everyone has the same risk tolerance.  Some traders will get depressed over a 10% drawdown, other traders will act like its almost nothing.  The simplest way to know your risk tolerance is sleep.  If the positions you take bothers your sleep, you have to size down.  Taking too much risk brings fear.  You can only function rationally and follow your plan when you aren't scared.  Scared money don't make money.  

Hope

"Losers average losers" - Paul Tudor Jones

Hope is what keeps us going.  What is a good thing in life, is not necessarily a good thing in trading.  Most people think of hope when things are going poorly.  When you are in a losing trade, hoping it gets back to even.  Or even worse, adding to the loser.  I add to losers and usually regret it.  Sometimes it works, which we remember, but usually it just makes the loss worse.  The time to hope is when your trading is "hot", not when its "cold".  But that's not natural, most people are wired to hope when things are bad, not when things are good.  

Nothing noteable in the SPX COT data as of last Tuesday.  Same goes for the put/call ratio and activity.  Did notice that commercial traders are accumulating a VIX net long position, which tends to happen near tops.  But SPX COT data is more important.  

Staying on the sidelines as SPX has recovered most of its losses from July 31-August 1.  It looks like it wants to grind higher before topping out.  Still keeping the view that this rally off the April bottom will take approximately 5 months to finish, so that would mean a top around early September.  Staying short some single stocks but mostly in cash.  A lot of potential energy being built up for a big down move, but some of that energy was released July 31-Aug 1.  This bull market is riding purely on technicals and momentum.  Most will agree that the fundamentals are not supporting such a big rally.  That's bubble psychology at work and it is fragile.  When the momentum dies out, it will get very volatile.

Significant Local Top?

Risk came fast.  It didn't wait for the tariff deadline to selloff.  Looking back, while a lot of traders were hedging for the August 1 deadline, there were probably quite a few who were also betting on a tariff deadline pop higher, as the tariff news flow was mostly bullish for the weeks leading up to August 1.  Add to that flashback memories of last August when you had a vicious 2 day selloff after the nonfarm payrolls.  That opened the trap door.

Suddenly, everyone, including Jim Cramer is talking about the weak seasonals and how August and September are weak months.  

Maybe Cramer is right this time, but a lot of investors are thinking the same thing.  Perhaps the caution on seasonal weakness is being front run.  Europe likes to take long vacations in August, so they were probably looking to lighten up on equity risk ahead of their long break.  

It has been nearly 4 months since the market bottomed on April 7.  It has been a long rally, but nothing out of the ordinary when compared to other rallies off of big selloffs.  The most recent example being the rally off of the August 5, 2024 bottom.  That rally lasted 6 1/2 months, hitting the high of the move in February 19, 2025.  But most of the upside of that 6 1/2 month rally was made in the first 4 months, with a significant local top made in early December.  Before that, you had a relentless 5 month rally off of the October 27, 2023 bottom, which made a significant local top in early April.  

SPX 2 year Chart

Based on the enthusiasm in meme stocks and cryptos in July, it feels similar to the post election euphoria last November/early December.  From December to February, the market chopped in a roughly 5% range from 5800 to 6100 for 2 months before the waterfall decline.  You may see something similar, but I would expect the choppy range trading time period to be less than 2 months.  Investors have added significantly to US equities in 2025, making it more likely for the topping process to be shorter.  Economic weakness is more apparent now than back then, so recession fears will flare up more easily.   

If you look back at the last bear market in 2022, it wasn't necessarily a big bond bear market that led to the stock bear market.  You've had bond market weakness without a bear market in stocks many times, including 1994, 1999, 2006, and 2013.  It was the fear of a Fed induced recession from a rapid increase in short term interest rates.  Back then, it was fears of the lag effect of higher rates and an inverted yield curve.  The stock market's primary fear is always weaker earnings coming from future economic weakness.  That is what caused the panicky selloff post Liberation Day. 

It was quite notable how strong the bond market was on Friday.  10 years yields have been trading in a range from 4.20% to 4.50% for several weeks, but it feels like it will break down from that range towards 4.0% or lower.  While Powell didn't reveal his hand for the next Fed meeting, there will be increased pressure to cut rates now that you've got a weak nonfarm payrolls report with weaker than expected CPI numbers the last 2 months.  Of course, these government inflation numbers are works of fiction, but the Fed and many of the brainwashed economic community take them as unadulterated facts.  Those in the real world know inflation is still raging hot.  

With "contained" inflation and a weak NFP, Powell will have plenty of justification for a September cut and more.  Given how well the market responded to last September's Fed cut, I'm sure that will keep many Fed obsessed investors bullish on the market during this topping process.  

History has shown that the worst bear markets happen during a Fed cutting cycle (2001-2003, 2007-2008), not a hike cycle like 2022.  This time, Fed rate cuts will have even less effect in stopping economic weakness.  One, the huge national debt actually neutralizes the positive effect of lower short term rates via lower interest income from T-bills and short term Treasury notes.  And the huge mortgage refi cycle in 2020-2021 means there will be limited stimulus from lower mortage rates if the long end yields fall.  There is no guarantee you will get much of a fall in long term yields due to the massive fiscal deficit and government debt load.  The view on long term US government debt is rightfully negative, as politicians have shown no willingness to cut spending or raise taxes despite worries from investors about the increasing debt and deficits.  

Short term, the Fed obsessed investors will keep this market from crashing, as Fed funds are pricing in a near lock for a September cut.  A stronger bond market also keeps the risk parity funds from selling stocks.  Lower bond yields are bullish for stocks, all else being equal.  But bond market strength is only a positive if the economy outperforms expectations.  Investors have been burned selling stocks near a bottom based on recession fears over the past 16 years, they have gotten complacent.  You can see the complancency in investor asset allocations, which have low cash levels.  Surprising with short term interest above 4%.  

The COT data as of July 29 showed a bit of buying from asset managers, but net long levels are still much lower than the highs late 2024.  Overall levels are still very high, so not really a sign of asset manager bearishness.  

SPX Futures Asset Managers

Looking for a bounce attempt early this week, which likely fails and we drop back down towards SPX 6200.  Looking for range bound trade in August, mostly between 6200 and 6400 on the SPX.  Trimmed some single stock shorts on Friday, but looking to put those shorts back on in the coming weeks.  Not looking to put on any big index positions until late August/early September.