Panic Point or Opportunity Zone?

Thoughts on the Market

This is our last Thoughts on the Market before we take a quick one-week summer breather to recharge and finally get our own dose of sunshine. Which, of course, almost guarantees that the market will choose that exact week to make the biggest move of the summer.

But just because we’re taking a break from writing doesn’t mean we’re taking a break from watching the charts. And that’s probably a good thing, because over the past few days our Proprietary Risk Model has fallen to within 0.0001 of flipping from risk-on to risk-off. So, it really doesn’t get much closer than that.

But don’t worry. Even if our Risk Model does trigger a defensive shift while we’re away, every paying subscriber will receive an immediate update with any changes.

At this point, though, nobody should be surprised that we’ve drifted back to this pivotal line. Over the past several weeks we’ve talked extensively about the market’s fading momentum, the headwinds from peak growth, and how the Fed has gone from the market’s biggest tail risk to an increasingly realistic fat-tail scenario.

That’s exactly why we got rid of our overweight position in Semiconductors four weeks ago — a move that has helped shield us from a lot of the recent damage. Now, with our Risk Model sitting close to the edge of a risk-off crossover, there are really only two ways to look at what’s happening:

1. You can panic, sell everything, and convince yourself the bull market is over.

   Or…

2. You can recognize that the very fact our Risk Model has fallen from elevated levels back to essentially zero also tells us something important: a lot of bad news has already been priced in.

As investors, panic is almost never a strategy. Every decision should be calculated. And just as importantly, we should always ask ourselves what could suddenly go right — not just what could go wrong. Because if this market has already spent the past several weeks de-risking, it also means there’s room for sentiment to improve again.

In other words, we’re standing at a genuine crossroads. Could we break lower from here? Absolutely. But could we just as easily reverse higher if some of these fears fail to materialize? Absolutely.

That’s why our game plan remains straightforward. If our Risk Model flips to risk-off, we’ll add stops to our tactical trades, add downside protection where it makes sense, and/or close positions right away. But as long as we’re still holding above this pivotal level, we’re not interested in hiding under the table. Instead, we’ll keep looking for opportunities in case this proves to be nothing more than another shakeout.

That said, last week’s dovish hints from Warsh appear to have been enough, at least for now, to send the Dollar Index back below its breakout level. And with a potential failed breakout now taking shape, a sharp unwind in the extreme bullish dollar positioning we highlighted last week could quickly turn the dollar from a major headwind into a powerful tailwind for risk assets.

Which only reinforces our point: instead of starting to panic here, we should remain on the lookout for opportunities.

And indeed, there’s one corner of the market that’s really starting to grab our attention. So let’s spend the rest of today’s note looking at what could become one of the biggest winners if risk appetite returns in full force.