Futures are off moderately following Friday’s bounce from the Supreme Court’s ruling that the bulk of Trump’s tariffs are illegal.  The benefits which might have ensued from tariffs being rolled back, however, were almost immediately negated by Trump’s insistence that alternatives to the current tariff regime would be implemented. It’s yet another chapter in the year-long tariff chaos that has pushed inflation higher and injected unwanted uncertainty into business and geopolitical dealings.

continued for members…

VX is still broken out, but has yet to top last week’s highs.

The USD is still consolidating against both the euro and the yen…

…while oil and gas continue their stealth breakouts thanks to the credible threat of a shooting war with oil producer Iran.

It remains to be seen whether a wag-the-dog exercise in the Middle East is even necessary any more, as the tariff turmoil has kicked the Epstein matter off the front page for the time being.

Meanwhile, the strong recent PCE data drove Fed governor Waller to ponder whether a rate hike might be in order in March.

Annualized Q4 GDP came in much lower than expected: 1.4% versus 3.0%. At the same time, December PCE (ex food and energy) heated up from 2.8% to 3.0% YoY (0.4% MoM.)  These data don’t necessarily scream stagflation, but they more than whisper it.  We’ll see if the algos are listening.

Interesting goings on in the bond market, as the 10Y continues to counter oil/gas.

They’re usually in lock step. As YoY gas prices drop, CPI generally keeps pace.

But, RBOB futures are up 22% since Jan 5. The 10Y kept up until Jan 20, but has been plunging ever since.

It might be because it’s diverged so much from CPI. Looking at the chart below, you have to wonder whether the risk implied in the 10Y is problematic.  There’s no question that CPI is understated.  But, does that explain the growing divergence between the 10Y and CPI?

Historically, it’s an unusual phenomenon, code for “is this time different?” There are only a dozen instances over the past 80 years where the 10Y remained in as tight a band as it has since June 2023 (108 bps.) It’s worth noting that no prior episode with a band this tight has such elevated CPI to begin with. It’s also worth noting that the divergence between the two is building, which is unusual in the sense that most prior divergences peaked sooner.

Of the four most comparable episodes over the years, three had positive equity returns: Jul 96 – Dec 97 (+27.8%), Sep 05 – Aug 07 (+10.2%), and Dec 74 – Sep 76 (+26.7%.) The market fell about 20% in 1977 following the 1974-76 period.  It was relatively flat following the 1996-97 period. And, it was a disaster following the 2005-07 period. It tumbled 12% in early August, rebounded until October, then crashed 58%. But, it’s the fourth episode which might be the most comparable.

continuing…

Everything is great. GDP growth is supposedly strong. Unemployment is supposedly low. Inflation is supposedly licked. Nothing to worry about. So, why is consumer confidence at an 11 1/2 year low?  At 84.5 for January, the Conference Board’s index reached the lowest levels since May 2014 — all while GDP growth has been relatively strong.

“I’ve never seen anything like it. I’ve been doing this for 40 years…a long time to never see anything like this.”
Diane Swonk, KPMG chief economist

Confidence also dropped for well-to-do households which have been driving the strong spending data which have underpinned the economy. Current conditions have reached levels not seen since the pandemic, while expectations are actually worse than the pandemic lows.

The job market is a significant culprit, with confidence regarding the ability to find a job closely matching the reality. Note that these are not BLS data, which have been more suspect than ever since Trump fired former Bureau of Labor Statistics Commissioner Erika McEntarfer over data that didn’t flatter him.

The decline in job openings over the past several years has been in stark contrast to the rise in stock prices. Layoffs rose over 200% from December to January, with large job cuts at major employers such as Nike, Amazon and UPS.  According to the latest University of Michigan sentiment report, worries about job stability and earning potential in the next five year were “particularly elevated” for higher-income and higher-educated consumers. 

And it’s all happening at a time when inflation is still problematic for American households. Even if you buy Trump’s inflation numbers (I don’t) the recent decline in the rate of inflation certainly hasn’t brought prices down. The essentials are still about 30% higher than they were five years ago, sharply outpacing the 20% salary gains over that same period.

It’s not just lower income Americans who are hit hard by stubbornly high prices, but they are disproportionately affected. Wealthier consumers generally have larger cushions in everything from their bank accounts to their real estate holdings and stock portfolios.

“Traditionally, the economy is doing really well, but ordinary people are saying they’re not.”
Matt Stoller, American Economic Liberties Project

They call it the K-shaped economy because it affects the “have-nots” much more than the “haves.” But, as we discussed in our Look Ahead at 2026, it has always forced a Fed policy response that ends up affecting everyone — even wealthy investors.

Stay tuned.

* * *

The futures are bouncing slightly just prior to the open.

VX is still well above the TL from last April and its 200-day moving average. But it failed to make a new high last week, which means the downside risk for equities remains elevated but without confirmation.

CPI came out this morning. To no one’s surprise, both the MoM and the YoY prints were lower than last month. Also to no one’s surprise, the news is being ignored by the futures. First, Trump has had his finger on the button ever since firing the head of the BLS for reporting accurate but inconvenient truths. Second, an actual drop in inflation hurts the case he so strenuously makes that the Fed should lower rates.

Most of the Mag 7 prices are down sharply since our Jan 14 Look Ahead at 2026. The forecast we detailed back then remains the same.

They’re also down significantly just in the past week. The valuation analysis we shared on Monday remains the same.

A reminder of what we said on Monday. The thesis remains the same.

Stay tuned…

Late last night, the FAA announced that El Paso International Airport would be closed to all incoming and outgoing flights for the next 10 days. The only reason I can think of for such an action is that the US would be flying into Mexico to apprehend some drug kingpin, Venezuela style. Moments ago, they announced that the closure had been revoked – presumably because whatever security emergency had existed no longer exists. Just another day…

Meanwhile, less than a week after the largest number of job cuts in any January since 2009, a very positive job growth print was released (+130K versus 55K expected, 4.3% versus 4.4% expected.) Note that the job cuts data came from private outplacement firm Challenger, Gray & Christmas and the job growth print comes to us from the data-made-to-order folks at the BLS.

The futures think this is just fine and have soared by nearly 40 points…

…ignoring the shooting star candle that the DJIA left in its wake yesterday.

The only problem with this jobs data, of course, is that it shoots the odds of a Fed rate cut in the foot. It also suggests that the inflation print coming out Friday will be lower than expected.

While numerous indicators still suggest a significant/imminent downturn, VX is doing its level best to prevent a meltdown.

Stay tuned…

Futures are off moderately ahead of delayed economic data due out later this week. Friday’s knee-jerk rally took SPX to 7,000, so a pullback back below the SMA50 would be significant.

Note that a pullback to the SMA200 will soon be able to occur without producing a lower low.

As we noted last week, the bulls need VX back below that TL and its SMA200. It remains on the bubble this morning.

Another measure on the bubble: DXY.

With EURUSD reaching out 1.20 target and interest rates still rising, it has an important decision to make.

In Japan, the Liberal Democratic Party won by huge margins – a mandate for Takaichi and her expansionary fiscal policy agenda and large investments in “national champions.” The resulting rise in interest rates has halted the USDJPY’s recent rally, at least for now.

In the US, the divergence between the DXY and the 10Y continues.

Tech, software and the effects of AI on the Mag 7 continue to present significant risks to the market.

Stay tuned…

There’s a battle shaping up at ES 6580, where the 200-day moving average is about to catch up to horizontal support at the previous lows. If it doesn’t hold, the next major support is another 210 points lower.

Much will depend on whether or not AMZN can hold 200. If not, the next highest levels of support are way down at 175 and 147.

As always, VX deserves close scrutiny. Its recent breakout above the trendline from last April and its SMA200 is highly significant. Bulls need it to fail.

Note that in a V-shaped recovery, the DJIA has to contend with our target at the 1.618 Fib extension at 50,303.

If 2025 felt chaotic, 2026 is asking us to hold its beer. The major themes from last year remain stubbornly persistent: tariffs, artificial intelligence, conflicts in Ukraine and the Middle East, elevated inflation and unemployment, and political dysfunction. The only measurable change? Each has managed to become either demonstrably worse or at least more elegantly complicated.

Tariffs are still with us, but have expanded to additional countries and causes. Thanks to Trump’s whackadoodle tariff-laced threats over Greenland, tariffs have evolved into a tool to empower American imperialism. Of course, the Supreme Court might rule that he had no authority to impose them under the 1977 International Emergency Economic Powers Act. But Trump has a number of fallback options which, though more complicated and limited in scope, would likely get the job done. But, to what end?

Tariffs generate treasury revenues which could theoretically reduce the national debt. However, a recent study shows that 96%  of the costs are borne by consumers. Therefore, tariffs function as a regressive tax paid by American consumers on foreign goods, making them inherently inflationary. Any benefit to the national debt is likely to be offset by a weakening economy which inflicts the greatest pain on those least able to afford it. Economists describe this outcome as a “K-shaped economy” which is a clever way of referencing the financial divergence between the fortunes of the “haves” and the “have nots.”

Market Implications

What does it mean for markets? There, things get a little complicated, and more than a little counterintuitive.  The recovery after the tech bust of 2000-2003 relied on a sharp drop in interest rates. But, the GFC and Covid crashes followed a different pattern characterized by much more powerful policy responses. Since 2005, all sizeable divergences increase just prior to equity market peaks, experience a blow-off top during market downturns, then expand again once the inevitable policy response (rate cuts and QE) arrives.

The mechanism? While affluent households are more likely to be impacted by market downturns (the top 10% own over 90% of stocks), they are the primary beneficiaries of the subsequent policy response which drives stock prices back up. The have-nots surviving on unemployment benefits are unable to benefit from the rebound until it produces a broader economic recovery which lifts job prospects and income.

This creates a perverse dynamic. Really bad economic news is simply bad news if not severe enough to engender a policy response. But, it’s good news when it’s catastrophic enough to precipitate ZIRP and QE.

Where We Stand

I’ve created a “Divergence Index” based on income and spending and mapped it against the S&P 500 and fed funds since 1999.

I’m a big believer in the power of charts to illuminate important patterns. This one reveals four critical insights:

• • At 82.3, our Divergence Index is at an all-time high
  • The higher the divergence, the faster and more aggressive the Fed response
  • Each crisis temporarily reduces divergence, but subsequent policy responses drive it (and stocks) even higher
  • Each subsequent Fed response has been faster and more extreme

This pattern of [Crisis -> Policy Response ->Asset Inflation -> Higher Divergence] creates a policy put for assets but a “doom loop” for equality. Like the national debt, inequality has been steadily rising for decades and, importantly, the policy response has escalated alongside it. 

The Escalating Pattern of Fed Interventions

During the tech bust, the Divergence Index was in a modest range of 15-20, prompting gradual rate cuts from 6.50% to 1.00% over 2.5 years and never reaching ZIRP.  In the GFC, the Divergence Index spiked to 67.7, and the Fed cut from 5.25% to 0.15% in just 15 months. They maintained ZIRP for 7 years (from 2008-2015) and invented QE , injecting $4 trillion in liquidity. The recovery took 5.5 years.

In the COVID crash, the Divergence Index reached 70-73 prior to the crash. The Fed cut from 2.40% to 0.05% in just 2 weeks (the fastest ever.) Unlimited QE was unleashed immediately, reaching $5 trillion in a few months. Despite ZIRP being held for only 2 years and the fastest rate hiking cycle in history (as CPI soared past 9%) the market recovered in a record 5 months.

It’s hard to look at the fed funds line on the above chart without seeing that the policy responses were solid early warning signals for equity investors. It’s therefore impossible to look at the most recent fed funds decline witho0ut wondering whether the equity markets are headed for another downturn. Has the Fed seen the recessionary writing on the wall and, if so, what does the pattern suggest about the timing and size of any related correction? 

I examined all such Fed policy reactions since 1970 and the results were compelling. The correlation between Fed policy pivots and market peaks was strongly positive and remarkably consistent. Of 7 cycles examined:

• • All 7 experienced market declines
  • 6 were associated with recessions
  • Average market decline was -38.4%
  • Range: -19.9% to -56.8%

As of Dec 31, 2025, we were overdue for a similar outcome.  Spoiler alert: we still are.

• • 29.2 months had elapsed since the last Fed rate hike – a 90% increase over the 15.3-month average
  • 15.4 months had passed since the first Fed rate cut – a 23% increase over the 12.5-month average
  • The stock market had not yet peaked.

Bottom line, a substantial correction is overdue. Based on 55 years of data, there is a 95% probability a decline of -25% to -45% will occur in Q1-Q2 2026. 
 

If you want to know what time it is and not how the watch works, you can stop reading right here.

The Geopolitical Powder Keg

Still reading? Okay, let’s get into it. We’ve barely scratched the surface on the very significant geopolitical risks facing the US. The past several weeks have seen a dangerous rupture between the US and some of its closest allies – one that could easily spell the end of NATO. If the alliance were to dissolve in the wake of America’s threatened takeover (whatever that means) of Greenland and Venezuela, it would almost certainly greenlight China’s ambitions for Taiwan and Russia’s for Ukraine.

Taiwan produces 92% of the world’s advanced logic chips and controls ~64% of global foundry market share through TSMC. The economic stakes are staggering:

• • Chinese blockade: $2.7-2.8 trillion (-2.8% of global GDP)
  • Full invasion: $10 trillion loss (-10.2% of global GDP)

By contrast, the GFC produced a 54% crash in the S&P 500 with a mere 1.7% global GDP decline.

The Davos Debacle

Since this post is taking shape over a couple of weeks, we have had the opportunity to observe the geopolitical scene through the lens of the goings on in Davos, Switzerland. Many in America are accustomed to Trump’s ranting, raving and bullying. But it was truly stunning to watch Trump brag, insult, and threaten the world’s financial and political elite. No doubt, some in MAGA were heartened to see Trump being Trump, and algos were thrilled to learn that Greenland (or, was it Iceland?) would not be invaded. But, otherwise, it was an unmitigated disaster. 

Much has been written about the debacle, so I won’t pile on. Suffice it to say that Trump did an enormous amount of damage to any foreign relations which haven’t already been torched.  It’s not an overstatement to say that his buffoonery could mark the beginning of the end of American hegemony.  If the Davos speech didn’t do it, the threatening letter he sent to Norwegian prime minister Jonas Gahr Støre should.

It’s there for everyone to see: not just the gaslighting, but the erratic behaviour suggesting serious cognitive decline. In a single 24-hour period, Trump:

• • Threatened to impose 25% tariffs on countries which supported Denmark’s sovereignty over Greenland
  • Backed off and announced the “framework of a [non-existent] future deal” when markets tumbled and the EU pushed back
  • Threatened Canada with 100% tariffs when prime minister Mark Carney said what the rest of the world is thinking: that the US is no longer a reliable trade or defense partner.

It Was Fun While it Lasted

Is this the guy who should control the nuclear codes, negotiate with the China and Russia, or even represent the US in trade? The stakes are enormous.

Studies show that the dollar’s global reserve status saves the US anywhere from $250-500 billion annually through:

• • Lower borrowing costs
  • Reduced transaction and interest costs
  • Absence of currency risks
  • Sanctions power
  • Geopolitical and network effects

Foreign governments and investors have always turned to the US dollar for its liquidity and safety. What if the dollar lost its luster? Even a 50% ($4.5 trillion) decline in foreign holdings would increase yields by 90-270 bps. Imagine the de-dollarization cascade that would occur if the 10Y treasury soared from 4.5% to 5.4-7.2%. Actually, this isn’t hypothetical.  The dollar’s share of global foreign exchange reserves has already declined from over 70% in 2000 to approximately 58% today.

In just the past few days, the DXY came perilously close to breaking down below a channel dating back to 2009, dropping below the lows last seen in July and November. But there’s a crucial difference: back then, the dollar fell because interest rates were falling. This time, it’s dropping while interest rates are rising – a concerning divergence last seen in April 2025 when Trump announced his tariffs and the market plunged 21%.  Trump’s dismaying comments and erratic policies have produced a crisis of confidence in the US dollar which reflects the crisis of confidence in the US. 

We see it in the comments and actions by foreign heads of state. After the Davos debacle, both Canada and the UK struck trade deals with China. Predictably, Trump threatened to impose additional tariffs.

For years, Trump has expressed his preference for a low US dollar – presumably because it aids US exporters. But, the more likely reason is because a low US dollar typically occurs when US interest rates are low and, therefore, supportive of stock prices. A low US dollar-high US interest rate environment wouldn’t be so conducive to stocks. Such an environment would accelerate de-dollarization.

It’s shocking that the administration seems to either not understand the dynamics or maybe just doesn’t care. If they’re really concerned about inflation, they should. The US imports $1 trillion more than it exports. Since a lower dollar increases the cost of those imports (on top of tariffs) it increases inflation. Add in the reduction in foreign workers resulting from Trump’s  immigration policies, and the cost of everything increases even more. Twenty-five percent of those in construction, for instance, come from abroad. So do many of the scientists, AI researchers and engineers who are key to the AI bubble’s continuing inflation.

Speaking of Bubbles

AI continues to drive the S&P 500. While hugely beneficial in driving the index to recent highs, it now threatens current valuations – particularly among the Mag 7.  Collectively, Microsoft, Meta, Google and Amazon are expected to spend $470-527 billion on AI infrastructure in 2026 – up from $350-400B in 2025. This represents 94% of their free cash flow and, importantly, occurs as their AI earnings growth is decelerating has decelerated from 30% to just 18% – the slowest since 2022’s 41% crash. 

In my opinion, the market is telling us that a correction has already begun. The rotation is now clear, with equal-eight S&P outperforming the broader index and small caps beating large. Flows are leaving the concentration, which always precedes corrections. Differentiation is also making a comeback, with investors picking winners and losers. While Meta performed well after recent earnings, Microsoft was punished severely. 

Bottom line, the AI put is expiring, with the demise of “build it and they will come” thinking. Capex is now expected to show an immediate ROI, especially since it has often been debt-funded (Meta’s $30 billion deal) at a time when interest rates are vulnerable. Investors are skittish, particularly with SPX testing and retreating from 7,000. If our forecast of a 25%+ correction proves out, it would mean at least a 40-50%+ Mag 7 decline.  The writing’s on the wall.

We’ve already seen a spending surge, disappointing revenue growth, and a failure to monetize the AI capex. We should know in the next few weeks whether valuations can hold up, and whether NVDA will join the party after its Feb 25 earnings release. But, for now, we’re quite concerned.

The Day After Tomorrow

Investors can take solace in the fact that markets have recovered from every crash or correction they’ve ever suffered. The caveat, of course, is timing. A 20-40% decline in your portfolio is irrelevant if you don’t need to tap the assets for 20+ years. However, if you need a sizeable sum in a few months to purchase a new home or pay for a wedding, that correction is a real concern. Traders are also keen to know when a recovery is on tap.

If there’s a silver lining to our forecast, it’s that the Fed has a very strong track record of ever faster and stronger reactions to whatever financial calamity comes along. Remember, the calamity virtually guarantees a recovery through the Fed reaction function:

Stage 1: Divergence Rises

• • • Top 10% capture more income/wealth
    • Bottom 90% struggle
    • Political pressure builds

Stage 2: Crisis Hits

• • • Any crisis (pandemic, recession, financial)
    • Markets sell off
    • Pressure intensifies

Stage 3: Policy Response

• • • Fed cuts rates → Benefits asset owners (top 10%)
    • QE launched → Inflates stocks/bonds (top 10% own 90% of these)
    • Fiscal stimulus → Some to bottom 90%, but…
    • Inflation from stimulus → Erodes real wages of bottom 90%

Stage 4: Asymmetric Outcomes

• • • Assets inflate dramatically
    • Top 10% gain enormously (own the assets)
    • Bottom 90% get temporary relief, then fall further behind
    • Divergence increases → Setting up the next cycle

Over the past 20 years, our Divergence Index has been in a consistent uptrend, with each crisis temporarily reducing it, only for Fed policy responses to drive it even higher. The policy responses have also progressed, with larger and larger drops taking place over shorter periods of time. These responses, in turn, have produced faster and more powerful recoveries.

• • The Dot-Com crash began with divergence at 15-20 and involved gradual rate cuts over 2.5 years. At 5.5%, the total Fed response was modest and never reached ZIRP. The market took 13 years to recover.
    
    
  • The Great Financial Crisis crash featured divergence at 67.7. The Fed cut from 5.25% to 0.15% in just 15 months and maintained ZIRP for 7 years, from 2008-2015. They also invented QE, pumping $4 trillion into the markets. The result was a much speedier 5.5-year recovery.
    
    
  • The COVID-19 crash saw divergence at 70-73. The Fed cut rates from 2.40% to 0.05% in 2 weeks, the fastest cuts in history. It held them at ZIRP for two years (before soaring inflation forced the fastest hikes in history.) Unlimited QE was unleashed immediately, reaching $5 trillion in months. The V-shaped market recovery took 5 months.

The pattern is unmistakable: The Fed’s speed and magnitude of response is directly proportional to the divergence level. With the current Divergence Index at new all-time highs of 82.3, it’s reasonable to expect the most aggressive Fed response ever when the next crisis hits. I expect:

• • Virtually instant (~ 1 week) drop to ZIRP when the crisis hits
    
    
  • Immediate, unlimited QE (>$5 trillion)
    
    
  • A V-shaped recovery (faster than COVID’s 5 months)

Throw it all together, and the expectation is for a vicious downturn, followed by a powerful rebound. The question is not whether the Fed will respond in force, but much they’ll throw at the market and how long it will take the market to rebound.  

Summary

Market dynamics are a little different from the last few crashes. There is greater exposure in private credit and crypto but less in real estate. Oil markets will likely be better supported thanks to Trump’s strong relations with Saudi Arabia – though this could come undone depending on what happens with Iran.  Geopolitical risk is much greater than in 2020. And, though there’s plenty of room for the Fed to cut to ZIRP, inflation remains a concern thanks to tariffs and the breakdown in the US dollar.

As a result, there might be no more rate cuts until a recession or market crash necessitates one or the Supreme Court approves Trump’s wholesale line change at the Fed. The BoJ has recently shown interest in working with the US to protect markets, but the ECB might not be as cooperative since Trump took a chainsaw to EU relations. The EURUSD matters more to markets. 

And, let’s not forget about the Chinese. Known for playing the long game, their influence around the world grows every time America’s influence suffers. Aside from potentially taking control over Taiwan – key to the aging tech boom – their investments in US treasuries and markets around the world afford them a great deal of power over flows, yields and market prices. 

The administration has obviously shown a much greater whatever-it-takes interest in “protecting” markets.