AI Bagholders

This week has been a continuation of last week, as the tech unwind continues, while the defensive and less crowded sectors stay strong.  Breadth has been relatively strong, yet the markets trade weak.  Another week that debunks the old-fashioned technician's belief that bad breadth is bad for the market, and good breadth is good for the market.  

The AI hype which at a fever pitch in May and June, has resulted in a monster bull trap, leading to big losses for those late to the AI trade.  I keep hearing the same thing from retail.  How can the SPX be only down 2% from all time highs while all these AI stocks are down anywhere from 30 to 60% from all time highs?  Its because the inflows keep flowing into equity index ETFs, keeping a bid for SPX, while retail and hedge fund flows into tech are drying up as AI equity supply ramps up, putting downward pressure on AI stocks.  

Some similarities to 2021 over the past few months.  The scale of the pain this time is much greater, as retail investing is now much more pervasive.  Just another warning sign of pain to come for 2027.

Here is a picture of how AI has done versus the SPX.  High beta momentum is basically the speculative names in the AI trade.  Down 41% from the late June highs, while SPX is down just 2% from its more recent October highs, and above the levels seen in late June.  

We have not seen this kind of underperformance among a group of high beta momentum names vs the SPX since 2000.  Even more perverse, has the been the strength in the defensive and less popular sectors of the market, while tech is getting killed.  

On Thursday, Oct. 22, the worst day of the week for the SPX, down 95 points, here were the sector breakdowns:

This kind of extreme dispersion among sectors on a big down day is rare, with SPX equal weight up 0.5% or more and NDX down 2.5% or more.  Precedents were mostly in 2000 and 2001.  

The market is giving you some very obvious hints that the peak of the AI bubble is behind us, and the consequences of the AI bust are in front of us.   The market internals for the AI bubble in 2026 is closely following the pattern of the dotcom bubble in 2000.

The hyperscalers and OpenAI/Anthropic continue to try to raise more capital despite the challenging environment for AI right now.  META dropped a little dilution bomb in their earnings filing, warning of possible huge amount of capital to be raised.  Zuck went all in on the metaverse and failed.  Is this his AI version of the metaverse gambit?  

OpenAI is now targeting a lower valuation to raise more private equity capital.  

We are getting close to the point where the capital markets will start closing off for giants in the AI space like OpenAI and Anthropic.  They have shut off the IPO window for the neoclouds.  Its only a matter of time before they shut it off for the bigger players when it becomes more clear that the economics for the AI business model is worse than advertised.  There is a lot of hype about AI making employees so productive, but a lot of that productivity is going towards bullshit production.  AI generated images, cookie cutter analysis, mediocre articles and papers, etc.  Most of this is low value, which means AI compute will need to be priced low (low margins for OpenAI and Anthropic) to attract sufficient demand.  

There are gigantic compute commitments for 2027 and 2028 for the two LLM giants as data centers come on line.  You are looking at a potential credit disaster if the demand for the compute isn't sufficient, as I suspect will likely be the case.  That is a contrarian take because almost everything I hear is about the insatiable demand for compute from 15-minute AI experts like CNBC's Josh Brown.  

This bull market started in October 2022, has taken the SPX from 3491 on October 13, 2022, to 7844 on October 6, 2026.  That's a 124% return plus dividends in 4 years.  That's a huge move for an economy that's growing this slowly.  In the next bear market, investors may take comfort in seeing Treasury bonds rally while stocks fall, thinking that there won't be a repeat of 2022.  That's right, the next bear market won't be like 2022.  It will be a stock focused bear market, not a bond focused bear market.  There won't be much comfort in seeing their much smaller bond portfolio rally a few percent while their much bigger equity portfolio goes down 30-50 percent.   

BofA client flows for the weekend ending October 16.  Institutions have been heavy sellers in October.  

BofA clients were heavy sellers of tech for the week ending October 16.  Need to see more of this to get a short term bottom.

Retail is still buying the dip in semiconductors, as of Oct. 21.

Hedge funds have been driving the tech led selloff.  Can't tell anymore if hedge funds are the smart money or the dumb money.  They used to be the dumb money when retail only had a small footprint in the market.  Now that retail has gotten so big in the stock market, taking the mantle of dumb money, hedge funds are now a trail mix of both smart and dumb money.  Not as much signal to be gained from hedge fund positioning as in the past.  

Bonds continue to squeeze higher as CTAs cover shorts, and long tech/short Treasury bond pair trades get unwound.  The bond market has finally found a bull catalyst(the AI bust) which is actually a bear catalyst for stocks.  AI is the elephant in the room, sucking out all the oxygen, putting sticky inflation and the Fed hiking cycle into the closet where no one is paying attention.  I believe the past 2 weeks are a preview of next year.  AI will be the dominant driver for both stocks AND bonds in 2027.    

You still have not seen any signs of capitulation in the dark pool data. The 2 significant bottoms in 2026, in late March and late July had big drops in the DIX, getting down towards 40%.  Aside from one day (Oct. 15), DIX has been fairly high during this tech selloff.  

Nothing notable in the COT data as of Oct. 20.  Speculators remain heavily long NDX futures.  

The market had quite a strong bounce (stronger than expected) from Monday to Wednesday, shaking the convictions of some bears.  Having a smaller position makes it much easier to hang on to positions and withstand some heat.  Wednesday turned out to be a huge head fake.  The sudden enthusiasm over SPCX's revenue numbers and a possible SPCX/TSLA merger was enough to set the bull trap.   Thursday took back 3 days of gains in just a few hours.  Now that the market is closer to SPX 7600, there isn't as much downside to play for.  Covered half on Friday, and will the rest ride until Monday/Tuesday.  

Do not want to be short after FOMC on Wednesday, and the slew of tech earnings coming out Wednesday/Thursday of next week.  The bearish news flow for AI is getting heavy and the seasonal calendar is turning more bullish.  Base case is that the we make a bottom sometime next week, and then bounce.

Sneak Preview of 2027

Its getting real.  They hit the heart of the US stock market this week.  AI is the heart of both the stock market and the economy.  The financialization of the US has made the stock market the de facto economy.  That is why you saw the bid in Treasuries, despite the hot CPI and PPI numbers.  When investors sense weakness in the AI boom, it doesn't take a genius to connect it to the economy, and thus bond yields.  Going forward, expect a reversal of the positive correlation between stocks and bonds.  The 2022-2023 playbook is useless for this market.  It will lead investors astray during the AI bust.  We're in the 2000-2002 playbook, where tech stock weakness leads to bond market strength.  

Credit spreads for AI data center stocks are blowing out and investors are starting to question the sustainability of the AI capex boom.  Last month, Anthropic delayed its IPO, which was initially planned for October into November/December.  Firmus, an AI data center company, scrapped its $5B IPO plans this month, when there wasn't demand at a $30B valuation.  

The hot topic of the weak, CRWV credit spreads, are blowing out.  

AI data center bonds steadily weakening since July.

The hyperscalers have gone into negative free cash flow at current spend levels.  In order to have further growth from current capex, additional capital will need to come from equity/bond investors.  It appears that even at these higher yields, there just isn't as much demand as most expected from bond investors.  As for equity capital, if you push valuations to nosebleed levels, IPO buyers think twice about whether they can even flip  for a profit.  That's why you are seeing AI IPOs getting delayed.  After seeing how the SPCX IPO played out, people are realizing the upside is limited when you IPO at ridiculous levels.  There aren't enough speculators out there to chase these AI stocks at crazy valuations.  Those gamblers have already gorged themselves on AI names, and have little room to add more bags to their portfolio.  

Musk has front run the crowd brilliantly by taking up a huge chunk of equity capital before the other big AI players were ready to come to the money trough.  Now, Anthropic and Open AI will probably have to IPO at lower valuations than they want to, in order to attract enough initial bids.  

The parabolic phase of the AI bubble has ended.  The NDX is now 4 months into the choppy, messy, and sometimes violent sideways range that form a long term top.  For the SPX, it has been 2 months since the initial top just above SPX 7800.  The length of the choppy, range bound phase varies for each bull market.  The following are some bull market top charts for reference.  

2000:  Initial top in late March.  Range bound phase (5 months) until final top in early September. 

SPX 2000 Top

2007:  Initial top in mid July.  Range bound phase (3 months) until final top in mid October.  

SPX 2007 Top

2015:  Initial top in late November 2014.  Range bound phase with only marginal higher highs until final top in late July (8 months)

SPX 2015 Top

2018:  Initial top in late January.  Range bound phase with margin higher highs until final top in early October (8 months)

SPX 2018 Top

2022:  Initial top in early November 2021.  Range bound phase (5 months) with marginal higher highs until final lower high top in late March.

SPX 2022 Top

2026:  Initial top in August 2026? Range bound phase (2+months) until final top in ?

SPX 2026 YTD

YTD inflows into tech funds $142B, with 2.5 months left in the year.  

The market has been very complacent about the AI boom.  Huge growth for the next few years is viewed as a sure thing.  It shows up in the money flows, as you have seen enormous inflows into tech sector funds.  It wasn't like this in 2025.  In 2025, there were still lots of doubt about AI end demand and monetization.  The memory mania was just getting started.  Now, every fast money investor and speculator is bulled up on semiconductors and DRAM.   It is the worst possible setup for bulls, as a heavily saturated market with high expectations faces huge disappointments.  

This past week is a sneak preview for the main event in 2027.  2027 should finally usher in an extended bear market coming from the AI bust, as OpenAI and Anthropic have trouble paying off their debt obligations as it grows with each AI data center launch (many more scheduled in 2027 and 2028 compared to 2026).  That should percolate down the chain to the semiconductors, AI hardware and power providers.

GS Prime Book net exposure to semiconductors is still very high.  Net exposure is still more than double the levels seen for 2024-2025.  

Previous scares such as the yen carry trade in August 2024, the tariff fears in February-April 2025, and the Iran war in March 2026 were tangential to the main theme.  The main theme being AI.  This is the first time since the start of the bull market where the scare is coming from the heart of the market.  Open AI expected revenues lowered, CXMT tech breakthrough news in the HBM market, and Coreweave and AI data center credit spread blowing out.  This is not something that can be just shaken off and ignored.  Too many AI speculators are losing money.  They've been bleeding heavily since June, and its just gotten worse.  There is a ton of overhead supply waiting, as AI bagholders will look to unload on strength.

Despite the ominous signals coming from the market, Its likely that you will get a bottom sometime in late October.  But don't expect a big, extended bounce like you saw coming after the late March bottom.  I would expect the next rebound to last less than a month, with marginal highs at best for the NDX.  

Just based on the calendar, how late it is in 2026, I don't expect any big moves to the downside until early 2027.  The market is still up over 10% on the year, with 2 months left in 2026.  Money managers don't have urgency to sell off their equity holdings at year end, which would bring foward capital gains taxes by one year.  So its rare to see a market go down hard into year end when its up that much in mid October.  You did see a rare 4th quarter selloff in 2018 which crushed the market, but the market was never up more than 10% on the year, and spent most of the year +/- 5%.  There will likely be a golden opportunity to put on big short positions with high conviction in late December, to front run the delayed capital gains selling, as well as the coming AI bust which should begin to play out in earnest in the first half of 2027.

CBOE SKEW spiking as the market is falling.  Uncommon.  Usually SKEW spikes during rallies, not selloffs.  Last time you saw this was in early December 2024.  Market went into a choppy sideways range for 2 months before a big plunge starting on February 2025 opex.  SKEW is now at levels last seen in early 2025. 

 

VIX move relative to SPX was off the charts for Friday.  Reflected in the high SKEW reading, as demand for tail hedges spiked.  This is no ordinary selloff.  

Big volume coming in for VIX call options expiring on October 21 at the cash open.  Could keep VIX stable until they expire on Wednesday, then could see another wave higher in VIX afterwards if SPX selloffs later in the week.

The market has been quite underhedged since August.  Investors decided that SPX puts were unnecessary, and prices for near term OTM puts were taken down to very cheap levels.  The systematic options sellers got more aggressive, and they helped to contribute to lower realized vol.  It looks like that period of rampant put selling is behind us.  The VIX has finally woken up, and abnormally strong VIX is a short term leading indicator for SPX weakness.  I expect this VIX strength relative to SPX movement to persist until the week of the FOMC meeting and majority of Mag 7 earnings, from Oct. 26 to Oct. 30.  

You saw some interesting moves in the bond market this past week.  It caught me off guard, as I expected a hotter CPI number to keep bond yields higher.  But the ferocious selloff in AI rendered the CPI number as meaningless, and the Fed funds futures are now only pricing in about a 15% chance of an October hike.  It was as high as 60% odds right after the CPI number came out.  Much of the move higher in Treasuries, especially the long end, felt like short covering as CTAs are heavily short.  Its becoming clear that Treasuries (in particular, short to intermediate term) are now likely to be an inverse Nasdaq trade for the next couple of years.  It will catch some bond traders off guard who are still focused on inflation, instead of AI.  Expecting a monster bull steepening move in the yield curve for 2027.

Put on shorts in both stocks and bonds in the middle of the week.  Took the loss on bonds but holding short in SPX.  Should have shorted NDX but was a bit chicken little as I didn't have a premium entry.  Looking for initial downside target of SPX 7600, and then 7550 if downside momentum picks up.  Not looking for a big move lower, so playing smaller size.  The risk/reward for shorts should be much better in 2027, when it will be time to be more aggressive with positions and entries.  

Listless

The word that I hear a lot these days is resilient.  On CNBC, they are in awe of how resilient the stock market is.  They act like its a miracle that stocks are going up as yields continue to go higher.  Many are forgetting that yields have been going up since March along with the SPX.   Stocks can go up for a long time while bond yields are going higher.  Watching the bond market doesn't really help much when predicting the stock market.  

Then you have the breadth boys.  The same old technicians on Twitter complaining about bad breadth.  Those guys still think that strong breadth is the cure all for the world's ills.  Never mind that a broadening market with good breadth in January and February preceded the worst month of the year.  Same thing happened in July 2024 as the market broadened out, right before you had the worst 2 weeks of the year.  In the stock market, they never let facts get in the way of a good story.  

Rather than resilience, the more apt word to describe the market is listless.  It should feel more exciting than this.  If AI is as transformational as all the pumpers out there are saying, why does this market seem so boring?  Even a lot of the AI names feel waterlogged.  NDX is still in a long term uptrend, but now its going up in drips and drabs, you aren't seeing the parabolic frolic that you saw for most of 2024, second half of 2025, and in Q2 of 2026.  You get a couple of up days, everything looks great, and then you get an out of the blue gap down that takes back all the previous day's gains, just like you saw on Wednesday.  

The market feels saturated.  The chasers don't have to chase anymore to get their allocation of the hottest names.  They can wait a few days and they get their pullback, and can buy cheaper.  Why would anyone in this market want to chase strength when they can wait a few days and buy on weakness at lower prices?    When uptrends flatten out and you get sideways chop, chasers get punished, and regret buying into strength.  Those who are more patient are getting filled quicker, and don't feel the need to chase anymore, because pullbacks, while being shallow, are more frequent.  It reinforces the lack of momentum in this market.

A lot of money has poured into US stocks over the past 3 years.  In particular, the last 12 months.  Expecting these kind of equity inflows to continue is wildly optimistic.  We've had historic levels of money pouring in.  It seems like everyone has a big allocation to US stocks, yet many say that its the most hated bull market ever.  Its like Yogi Berra said: no one goes there anymore, its too crowded.  

We are in that awkward period where stocks are still in an uptrend, but the trend is weakening, and the majority are heavily allocated to the best performing names, which are outperforming, so no one is really worried.  They talk about bond yields and how they could hurt stocks, but I still hear a lot of those CNBC experts who think that the Fed could just hike one more time and be finished with this rate hiking "cycle".  There is still plenty of denial out there.  Many are still skeptical that the Fed will continue hiking rates beyond December into 2027.  The STIRs market is pricing in 4 more hikes for the next 12 months.  I'll pick the market prediction over a CNBC talking head any day.  

All this talk about the bond market is a distraction from the real mover, AI.  All it took was an FT rumor about OpenAI revenue estimates being $20B less than forecast to trigger a quick intraday downdraft.  After the dust has settled, all the NDX outperformance over SPX since September 21 has been erased in a span of 2 days.  That is meaningful.  The NDX strength made me hesitant to short this market.  Now that NDX is no longer outperforming, it makes me want to short the next bounce that comes.  

BofA client stock, bond, and cash allocations, as of October 1.

BofA client flows for the week ending Oct. 02.  Institutions were heavy sellers, while hedge funds were buyers.  

Schwab Trader Activity Index for September.  Remain near highs over the past 3 years.  

SpaceX saw net flows 50% higher than the second-ranked stock, with buying peaking in the final week of the month. The size and timing of the flows suggest enthusiasm remained strong rather than fading as the month progressed.

Post opex Octobers (starting October 16) have been historically weak.  

They continue to buy the dip in the long end.  

Mag 7 net exposure at 5 year highs, MAGS ETF monthly inflows at all time highs.

Heavy inflows into government bonds last 2 weeks.  

Lot of speculative call buying in TLT.  

Rising global bond yields are a symptom of a lack of liquidity at current prices for stocks and bonds.  When there is plenty of liquidity in the system, you get both stocks and bonds rising.  When there is a liquidity constraint, it is difficult for both stocks and bonds to go up together.  In the short to intermediate term, stock-bond correlation is mixed.  In the long term, bond market weakness is often a leading indicator for stock market weakness.  

The big event for the coming week is the CPI on October 14, and opex on October 16.  I expect a grind higher into the CPI number, and then a pullback afterwards as we get to the 2nd half of month.  Still on the sidelines waiting for a bit more of a rally to put on shorts, in both stocks and bonds.  This time, the time frame for the short trade will be less than 2 weeks.  It still feels too early to put on long term shorts, as we likely get a post election relief rally in November, even with a Democrat sweep of Congress.  

Bonds in the New Normal

The ZIRP/QE era was the biggest anomaly in financial history.  It lasted for over a decade, so it left a lasting impression on fixed income investors, who are still adjusting to the new normal.  The distortions created by ZIRP and QE make investors view 10 year bond yields at 5% as being very high.  But a 5% 10 year yield would have been considered very low from the 1970s to the 1990s.  Looking from a big picture historical perspective, ZIRP/NIRP was insane monetary policy.  Paying people to borrow money, or letting them borrow for free is insane in a fiat world of ever increasing money supply.  

I remember back in 2009 and 2010 when everyone was waiting for the Fed to get back to more normal, higher interest rates and it kept getting delayed and delayed with various excuses.  It was excruciatingly slow how they tapered QE, how they stayed at ZIRP, how worried people were about rates getting too high in 2018 when Powell went from 2.25 to 2.50% on Fed funds.  Looking back, investors were out of their minds, thinking 2.5% Fed funds would crush the economy.  

You still hear the voices on CNBC, Twitter, who say that the Fed doesn't need to raise rates, even with sticky inflation.  That is based on the distorted views coming from over a decade of ZIRP and low interest rates.  Many people still view 4% Fed funds rates as being restrictive.  Its not restrictive when the US government runs 6% deficits during an economic expansion and an AI investment boom.   In a recession, those 6% deficits easily double to 12%+ deficits.  Probably even higher as politicians pump out monster stimmy and pork packages during a downturn.  

Fiscal dominance makes high interest rates less effective in slowing down the economy, due to the sheer size of the national debt, and the amount the Treasury funds the deficit using T-bills.  Higher Fed funds rates quickly result in higher interest payments to T-bill buyers, which is a kind of fiscal stimulus on its own.  

The current 6% deficits are papered over with Treasury issuance running at over $2 trillion per year.  There is a supply/demand mismatch.  Without the Fed doing QE, you are left with price sensitive buyers who only buy if the yields are high enough.  Foreign buyers who have to recycle US dollars from their trade surplus would rather buy gold (China) or US equities (Europe) than US Treasury paper.  The government has clearly shown that it doesn't care about deficits.  Most voters don't care either.  They want lower taxes and all the benefits they get from the government.  The government is addicted to tax cuts and spending increases for defense, Social Security, and Medicare, because that's what's popular.  The US population is aging.  There is no way old voters are going to vote for anyone that wants to cut SS and Medicare. 

Inflation is the easiest political choice, because politicians can keep handing out feel good stimmies and tax cuts and blame others for the inflation that comes afterwards.  This reinforces the bond bear market, as high inflation and high interest rates aren't enough to change political behavior.   The only permanent break from this vicious cycle of high inflation and higher bond yields is political austerity.  There are absolutely no signs of that happening.

During this secular bond bear market, there will be cyclical up moves in bonds.  Just as there were cyclical down moves in bonds during the 40 year bond bull market from 1980 to 2020, there will be cyclical up moves in bonds during this bear market.   Its going to need a trigger.  The most obvious one is not the end of the Iran War.  Its the end of the AI investment boom.  The AI bust cycle is the only thing that will stop this bond bear market.  

You will need a bear market in SPX to get a cyclical down move in bond yields.  And most of that down move in yields will happen in the front end of the curve, with the Fed cutting rates, but because deficits will get bigger, long end yields will fall much less.  While the crowd has been conditioned for equities to go higher when bonds go higher, it will be return of the inverse correlation that you saw for much of the dotcom era and post GFC.  In order to get bonds higher, stocks need to go lower.  Its ultimately the stock market that will determine the path of financial markets, not the bond market.  

Retail aggressively buying TLT lately. 

Global growth leading indicators are showing a slowdown for the next several months.  

BofA clients were big sellers for the week ending Sept. 25.  It is an unwind of the heavy buying they did earlier in September. 

GS Prime book leverage for L/S hedge funds shows net exposure at the 2th percentile over the last 5 years.  

Foreign investors were big buyers of US equities in the 2nd quarter.  

AI continues to drive the NDX outperformance over SPX.  It makes me wary of aggressively shorting here.  Still want to take advantage of any rallies to the top of the range to short both NDX and SPX, but probably need another 50-70 points higher in SPX to get a good risk/reward.  Perhaps a dead cat bounce in bonds could provide the premium entry point for equity shorts.  Probably just as good if not better to short long term Treasuries on a bounce.  It just doesn't feel like a bottom for bonds with the lack of fear, poor price action, and seasonal factors.  

While all the talk is about the bond market lately, the effect that bonds have on equities is overrated.  When oil prices go down and bonds bounce on news, it can be used as a good entry point for equity shorts.  But given the lackluster price action and NDX strength, I would only want to put on a small to medium sized short if an opportunity comes up.  Its probably better to save most of your bullets for 2027, when a much more favorable backdrop for short selling comes, as the AI boom slowly turns to a bust.  Until then, don't get buried shorting too early.  As for going long, its too late in the bull market to buy anything but a pullback where fear is palpable.  Haven't seen that since late March.

Return of AI Momentum

NDX relative strength vs. SPX was slowly building for several days before the explosion higher on Monday, 9/21.  Semiconductors ignoring the AI safety news spread by the CEOs of the big AI firms was an early sign.  META Muse news was the spark that got speculators excited about AI again.  I don't expect it to last for long, as Muse is just the latest overhyped AI agent, just like Openclaw was earlier in the year.  But I also don't want to risk getting run over being short if this speculative wave lasts for more than a few days.  

Anthropic delaying their IPO into November has been a blessing in disguise for the Nasdaq.  The delay has made tech/growth funds less urgent to raise cash to buy the IPO.  That eliminates a near term bear catalyst.  Anthropic is obviously having trouble building up enough of an investor pool to buy into a $2T valuation.   Its an early peek into investor demand for a $2T market cap money bleeding company that has lots of competition from not only Open AI, but more importantly, from China.  Its not going to be easy for them to raise as much capital as they want at their preferred valuation.  They will either need to raise less at a higher valuation, or raise more at a lower valuation.  Either way, I can sense that there just isn't a lot of enthusiasm to buy into the IPO when the trend is toward using lower cost Chinese open weight models.  

But everyone is saying this market can't keep brushing off higher bond yields.  Why ignore rising bond yields and just focus on the NDX, when CNBC is talking about bond yields every day?  Its because investors are buying stocks because of the AI boom, and that's directly related to the NDX.  50 bps higher bond yields doesn't change an investor's decision to buy stocks or not.  The performance of AI related stocks does.  NDX strength is the most important barometer for the US stock market.  It is the fuel that feeds this bull market.  NDX has been outperforming SPX and IWM massively for the past 2 weeks.  

NDX outperforming SPX/IWM is the simplest signal of risk appetite.  Contrary to what all the technicians tell you, it is not the number of stocks going up that is important.  It is the number of the most heavily owned stocks going up that is important.  The most heavily owned stocks are AI related tech, in particular semiconductors.  If the most heavily owned stocks by speculators are outperforming the SPX, then you are not likely to get a big down move.  

Downtrends happen when speculators are losing money and forced to sell.  The type of investors that are losing money is important.  If value investors are losing money, that doesn't mean much.  Value investors don't sell when stocks go down, they usually want to buy more.  Same goes for most bond investors.  But stock investors, in particular fast money stock investors, are mostly trend followers.  When stocks are going up, they buy more.  When stocks are going down, they either stop buying or they sell.  The marginal supply and demand determining short term market direction is coming from these momentum based investors.  Pod shops are now big participants in the fast money trading game. Most pod shops are momentum based.  Why?  Because they have tight stops, and by the very definition of having tight stops, you have to be with the trend or you get stopped out.  

That being said, NDX outperformance doesn't last forever.  When it turns, it can lead to vicious down moves not just for NDX, but for the broader market.  The more crowded the NDX long position, the sharper the down move when it happens.  My gut feeling tells me this NDX over SPX trade doesn't have a lot of room to run.  Tech is just too heavily owned by retail, by hedge funds, and the biggest IPOs are all in tech.  Perhaps we get a sharp reversal in the NDX over SPX trade right ahead of the Anthropic IPO in November.  Similar to the NDX weakness vs SPX in June ahead of the SpaceX IPO.  

Net equity demand from Federal Reserve data as of June 30, 2026.  Investor inflows into stocks are doing the heavy lifting, as corporate net repurchases goes negative.  

Investors want either tech ETFs or index ETFs.  Nothing else.

The stock market is becoming the piggy bank for consumers.  The stock market is becoming the economy.

A quick word on bonds.  Based on the speed and continuous downtrend in bonds, it looks like we are into the capitulation phase for bonds.  The top in 10 year yields in 2006 and 2007 around 5.25% is a psychological resistance level where you could see some buyers stepping up.  Bonds are not a screaming buy, like some kneejerk contrarians are stating, but we are getting close to levels where you can buy for a high probability short term trade.  Long term fundamentals are still poor as supply is huge, inflation is sticky, and the AI boom still ongoing.  

The original plan was to hold for a big move lower as we were in a seasonally weak window, along with a complacent market that was grinding lower, with no signs of investor capitulation, and with NDX being a relative underperformer vs SPX.  That all changed, and the market is shrugging off the relentless rise in bond yields.

So I scrapped the plan and got out of all shorts this week, as NDX outperformance was just too much to bear.  You have to trade the market that is, not the market that you want.  Its just unlikely that you'll get that big move lower that I was expecting for September/October.  It doesn't mean I'm completely giving up on shorts in the near term.  Without a big move lower, one has to be more tactical and short only at certain levels, and cover when you get pullbacks.  

We never got the capitulation during the 1 month slow grind lower from mid August to mid September, so I don't expect an extended rally.  This week, you've already seen a total retracement of the big Monday up move in SPX.  That's not common.  Usually a total retracement of such a big move takes several days to develop, not 2 days.  So you aren't getting any V rallies this time.  It means that rallies are shortable, but that profit targets need to be reduced and you need to get out of shorts on dips, with expectations for another bounce coming again.  A bounce towards SPX 7780 to 7800 would be enough to get me interested in re-shorting. 

Volatility is Flatlining

Over the past week, we got all kinds of news and events, but the market has gone nowhere.  The AI news about slowing the pace of AI investment due to safety concerns, which seemed like a nothingburger, but people made a big deal out of it.  And it ended up being much about nothing.  Ever since that news came out last weekend, NDX has been outperforming SPX.  

The talk of the town this week was the Fed rate hike.  The market didn't seem too concerned, as it didn't really selloff much going into the FOMC meeting, and then you got a stop run after Warsh came out more hawkish than expected.  It seemed like an overreaction to the news.  What were people expecting?  A one and done announcement, a dovish hike?  The Fed never does that.   Especially non-forward guidance Warsh.  A dovish hike is like jumbo shrimp.  Fed reactions are usually overreactions and often reversed in the following day.  That's exactly what happened on Thursday.   

Those looking for a quick strike in this market have been disappointed.  It is quite unusual to see such a dull market when the market is making lower highs and lower lows.  Usually investors get worried when stocks are making lower highs and lower lows.  But the down moves have been small, so investors have shrugged off the weakness, expecting a rally to come to save the day.  And that's what's been happening.  Investors don't want to sell weakness, and they are not heavily hedged with puts, meaning gamma selloffs are unlikely.  So you get weak selloffs, which often reverse.  

One of the best indicators of retail investor flows is the DIX index, which shows dark pool short selling by market makers, which take the other side of retail orders.  They are going higher as the market is going sideways.  A high DIX is not necessarily a bearish signal, as DIX was high for much of the April to October 2025 rally in SPX.  But they are a warning signal of potentially more selling when retail is buying the dip and the market is trading sideways, like now.  Previous similar instances were early March 2026 and mid July 2026.

Last week, for the week ending September 11, BofA flows showed a big outflow from all investor types.  But this just partially negates the big inflows over the previous 4 weeks, as the 4 week flow is still positive.  

A note on the retail flows from BofA and implied by DIX.  BofA private clients are wealthy retail investors, while DIX is a representation of the payment for order flow retail brokers like Robin Hood, Schwab, Fidelity, E-Trade, etc.  

According to GS prime broker data, from Aug. 28 to Sep. 10, hedge funds were heavy buyers of tech stocks.  

Leopold apparently continues to splash around in the options market, buying OTM calls on high beta AI plays.  These options expire within 2 weeks, so he's basically buying expensive short term lottery tickets.  The guy just can't sit still.  Money continues to burn a hole in his pocket.  A degenerate gambler running a $10B hedge fund.  

You got a couple of investor sentiment surveys out this week, showing many more voting bearish.  In particular, the AAII investor survey showed a big jump in bears.  Yes, if you get these bearish numbers for a few weeks, its a good bottom indicator, but its just been one week, which often means more weakness ahead (see February/March 2025, mid March 2026).  

We've seen heavy inflows into TLT, as long bonds have been selling off for months.  Usually this happens in an uptrend, not a downtrend.  Being bullish bonds may seem contrarian, but the crowd has been buying, not selling.

SPX COT data as of 9/15 shows small speculators with a big reduction in net longs, ahead of the FOMC meeting.  

Short term, the market is lulling investors into complacency.  But we are seeing early signs that investors are starting to get worn out, as you have seen put/call ratios slowly rising, more bearish responses to investor surveys, and some investor outflows.  Now that September opex is behind us, we are in a very bearish 10 day period where investors have on less put protection and the stock buyback window closes.   One thing to keep an eye on is NDX outperformance over SPX since last Friday.  If it continues, it would make me less bearish and I will reduce my shorts.

I covered the rest of my shorts before the FOMC meeting, earlier in the week, and have put back on shorts on Thursday and Friday.  I want to be short going into the most bearish 10 day window of the year, as investors are starting to get worn out and more likely to lighten up on stocks.