Inside Markets — Pain Trade
Pain Trade
January 17, 2025
Heavy money market inflows to start the year suggest investor caution into an expected avalanche of executive orders on immigration and tariffs following Monday’s inauguration of Donald Trump. These two items are the easiest to address, but also relatively unpopular from a market perspective. While lower immigration generally leads to slower growth and tariffs come with a temporary inflation impulse, it is also important not to lose sight of the pro-growth/pro-cyclical parts of the agenda where there is reason to be optimistic. Tax reform is hard to pull off, but deregulation in the current environment should be relatively easy.
The Russell 2000 (RTY) and S&P 500 (SPX) triggered momentum divergence buy signals at the close on Monday, while both indices were in short-term oversold territory. The signals generally align with a month-long period of mean reversion, which should carry markets into a wide-open corporate buyback window. The largest source of equity demand in 2025 will likely be corporate buybacks for a second year after record authorizations in 2024. The corporate buyback window begins to reopen next week with the week of 1/27 open to 45% (peak) of the S&P 500 by market cap.
It is important to keep an eye out on a potential pro-cyclical rally because it would likely lead to some unwinding of crowded trades – namely in mega-cap Mag 7 stocks. Our early-warning indicators include the relative performance of the RTY/Nasdaq 100 (NDX) and the copper/gold futures ratio. In July, the RTY finally broke out of multi-year range resistance, but the move ultimately failed without a rise in copper prices. In our view, a legitimate/lasting pro-cyclical rotation requires a simultaneous and sustained breakout in RTY and copper. The RTY should outperform the SPX in this expected month-long mean reversion. Meanwhile, copper prices have been advancing. But, the two markets have a long way to go. The RTY/NDX ratio also flashed a breakout (above 0.116) in late November before retreating to the lower levels of the 2024 range.
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