A market near highs but no longer in its early phase
My equity risk model sits at about 49%, essentially neutral. That is more cautious than you would guess with the S&P 500 near record highs. The model gauges the one to three month outlook, sorting risk-on from risk-off. It picks up that the momentum from the second half of last year and early this year in the most volatile stocks - the technology leaders - has slowed. Money is rotating away from the most volatile names into other parts of the market. That rotation is usually step one in moving from the early stage of an intermediate-term rally to the later stage. It is an early warning: we are no longer in the early phase of this move. Even near new highs, the underlying mechanics look older and the risk profile is weaker than before.
The Fed shift from tailwind to headwind
For several years the Fed was either cutting rates or holding steady. In the last few months the market has started to price in rate hikes - even one or two. That flips the Fed from a tailwind to a possible headwind. There is heavy uncertainty about how the Warsh Fed will act and how it will respond to inflation that has run above target for years and may be turning the wrong way again.
Fiscal policy, global macro conditions, and geopolitical risk would normally call for rate hikes, especially given AI capital spending (capex), which drives demand rather than being a supply shock from energy. So there is more pressure on the Fed to raise rates. That weighs on investor sentiment, which had long treated the Fed as at least neutral, if not a tailwind.
Warsh has offered little guidance, a real break from past Fed chairs. The market is trying to work out the Fed's response function - how it reacts to different data. The data is mixed: labor readings show some positive, some negative; some inflation metrics improve while others worsen. Headline inflation stays high and is getting closer to the fed funds rate itself, leaving room for a hike or two. With a lot of money still floating around from fiscal policy and big tech capex, the Fed would typically want to lean against that and push rates up.
Fed-watch odds and who is exposed
Current market-implied odds: 65% chance of no change in September, 35% chance of a hike. By December, 67% chance of a hike, and 0% chance of a cut at either meeting. Expectations swing erratically with every headline and data point because the predetermined strategy investors grew used to under past chairs is gone.
Financials and banks benefit from a steeper yield curve, which has steepened a lot recently. Housing stays under pressure from elevated rates. Home Depot (HD) still feels that pressure. Non-AI construction across the economy is relatively weak. Only data centers keep seeing spending come through despite rates. Rates still hit the traditional parts of the economy but not the tech, data center, and AI parts so far.
Why the VIX is too low
The VIX sits at 15.79, near record lows and off the lowest levels in a long time. Against this uncertain backdrop, this looks like a VIX that is too low. Individual stocks have been far more volatile than the VIX suggests. The indices stay stable because stock correlations are low and there is heavy rotation and dispersion. On a down day, technology stocks fall while healthcare, consumer staples, and other sectors rise, so the indices barely move even as volatility and risk build under the surface. Investors are nervous, moving fast between tech and everything else, or even between semiconductors and software inside tech. That finely tuned diversification and very low correlation is unusual and cannot last forever.
The macro backdrop - geopolitics and rates - adds risk. Earnings have been very strong, but Q2 results did not get the market reaction that very strong Q1 results did. That signals expectations are very high, with more downside to expectations now than a few months ago. As fall arrives, volatility may start to pick up again.
Buy and avoid names
The weekly buy list screens for stocks where earnings estimates are still rising, valuations are reasonable, and price momentum is supportive. The ideal setup: rising estimates, a stock that has done well, then a pullback that gives an entry point. Several technology names fit, including Super Micro (SMCI), which is on the buy list. The list is not strictly a technology or AI tilt - names from other sectors qualify too.
MicroStrategy / Strategy (MSTR) is an avoid. An earnings-estimate approach does not work well on it because it is asset-based: it basically owns Bitcoin, with leverage, and follows whatever Bitcoin does. Bitcoin has been weak and that leveraged Bitcoin-owning strategy is unwinding. The business model looks broken, or was never strong to begin with, and it lacks the earnings a traditional company has. It is an asset play with the asset going the wrong way.
Tesla (TSLA) is also on the avoid list.
