The Stock Market's Rough Start to 2025 May Be Just a 'Trump Bump'

The U.S. stock market appears unsettled, with the S&P 500 stuck in a trading range since early November. After a significant selloff in mid-December, the index showed an oversold condition on December 20. Despite attempts to rally, it remains under pressure, hovering near its December lows. A decisive breakdown could push the index down to its 200-day moving average at 5,573.

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Is the Bull Market Losing Momentum?

Four weeks ago, I highlighted the public's optimistic response to a "Trump honeymoon" rally. Typically, such a scenario would lead to a sustained relief rally by now. However, the market's inability to recover raises questions about whether the honeymoon phase has ended and how much patience investors should have with the bullish outlook.

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Searching for the Bearish Catalyst

The market’s failure to rally despite being oversold suggests a deeper concern about potential risk factors. If so, what is driving this cautious sentiment?

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For now, falling bond prices are pressuring stock prices. This could be tied to slowing economic growth, as reflected in the declining Citi Economic Surprise Index, which tracks how economic data performs relative to expectations. Normally, such conditions would lead to declining bond yields and rising bond prices. Yet, bond yields have increased, defying expectations.

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Another possible explanation is that central banks may be losing their grip on bond markets. Despite a global trend of monetary easing, yields on long-term bonds have been rising. U.S. Treasury yields have surged alongside European bond yields, with notable turmoil in U.K. gilts. The stronger-than-anticipated December U.S. jobs report further fueled Treasury yield increases last Friday.

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The term premium—a measure of the additional return investors demand for holding longer-maturity bonds—has risen significantly. The 10-year term premium is at levels not seen in over a decade, outpacing the rise in the 5-year term premium. While these trends suggest growing inflation fears, the inflation factor trade of long-term inflation expectations and short positions on zero-coupon long Treasuries has yet to surpass October 2023 highs.

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Bond market sentiment reflects elevated inflation concerns, but these are not extreme by historical standards. Despite these signals, they fail to fully explain why U.S. stocks have struggled to rebound.

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Uncertainty Over Trump Administration Policies

Another possibility is the market’s unease with the risks tied to the Trump administration. While optimism about pro-growth policies and tax cuts initially buoyed stocks, fears of a trade war and uncertainty over foreign relations with countries like Canada, Mexico, and Denmark have weighed on sentiment. Markets tend to dislike uncertainty, and it’s plausible that investors are waiting for clearer policy direction before committing to bullish positions.

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Trusting Proven Models

Despite the uncertainty, technical models with strong historical track records offer a reason for optimism. One such tool is the “Bottom-Spotting Model,” which has successfully identified tactical trading lows over the past five years. The model triggers buy signals when at least two of its five components flash oversold conditions:

1. The VIX Index spikes above its upper Bollinger Band.
2. The VIX term structure inverts, signaling heightened fear.
3. The NYSE McClellan Oscillator indicates an oversold condition.
4. TRIN spikes above 2, pointing to price-insensitive selling.
5. A ratio of stocks above their 50-day moving average versus their 150-day moving average falls below 0.5.

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Historically, this model has indicated buying opportunities, with most signals leading to rallies. Notable exceptions include the COVID-19 crash and one instance in 2022.

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Another reliable indicator is the NAAIM Exposure Index, which tracks sentiment among registered investment advisers (RIAs) managing client funds. A buy signal is triggered when the index reaches the bottom of its 26-week Bollinger Band.

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Failures of this signal are rare, even during major crises such as the 2008 financial collapse, the 2011 Greek debt crisis, and the 2020 COVID crash. Two weeks ago, the index flashed a buy signal, and its recent stabilization suggests diminishing fear.

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A Cautiously Constructive Outlook

Currently, the market displays a risk-off tone with few concrete bearish catalysts. Rising inflation fears, coupled with uncertainty surrounding Trump’s policies, seem to have made investors cautious. However, the technical models with robust historical performance suggest that the risk-reward balance remains tilted toward the bullish side.

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This situation appears to be more of a "bond market tantrum" than a repeat of severe crises like the 2008 financial meltdown or the COVID crash. Historical studies from portfolio managers such as Steve Deppe and SentimenTrader also point to a potential bullish rebound. Investors will soon gain clarity from fourth-quarter earnings reports and the upcoming CPI and PPI data. A weaker-than-expected inflation report could significantly alter the bond market's bearish narrative.

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Key Risks and Technical Perspectives

The primary risk to this bullish outlook lies in a breach of the January 10 support level. If this support fails, it could lead to a decline to the 200-day moving average at 5,573. However, the decline is unfolding amidst positive divergences, as indicated by the 5-day RSI and the percentage of S&P 500 stocks above their 20-day moving average.

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The Russell 2000’s support breach is less definitive but shows similar positive divergences. From a technical standpoint, this market episode resembles a standard bond-market correction. The 30-year Treasury yield is testing resistance within a rounded-top formation, signaling that this bout of panic may soon subside.

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