Rubber Meets the Road

As I have been saying, it's time to buy the dip. But what to buy? The answer may surprise you. Just look down at your feet.

A chilling 'AI Bubble' narrative is suddenly dominating the investing zeitgeist. NVDA will report earnings tomorrow, and fear and loathing are already priced in. Despite last month's hyped-up Investor presentation that featured CEO Jensen Huang's "half a trillion" backlog revelation, over the past two weeks, the stock erased the Pavlovian rally it experienced following the meeting. The sell-off may already be over. But I'm saying the easy money has already been made in this market for the AI trade — time to look elsewhere for performance.

Nvidia

I am more interested in the non-AI rotation trade that is likely to result from the Federal Reserve's now year-long easing of interest rates. Yes, the tech trade has come under scrutiny lately as valuations have soared alongside investor engagement. But it's not likely to generate market-beating returns from here, even if this sell-off is just a bump in the road. It feels more like a seventh-inning stretch than the end of the game, but the market's narrow leadership phase is over.

As I have argued recently, economically sensitive stocks are poised to enter the race for alpha. When banks start rallying against technology stocks, as they recently have, the 'cyclical' trade is upon us. The chart shows an inverse relationship between lower rates and the relative outperformance of financials over technology stocks.

Financials vs Technology

Another way to look at this trade is from a deep cyclical perspective. When copper prices outperform the gold market, financials outperform concurrently. Bank revenues are partly cyclically driven as loan growth expands. Again, we need to see the turn here, but I'm betting it will happen. Seasonality is now positive for Copper.

Copper vs Gold; Financials vs Market

But what about the rest of the market? Homebuilding, autos and apparel stocks have been underperformers this year - all consumer discretionary stocks. If the interest relief and tariff relaxation finally filters through to a shell-shocked U.S. consumer, there is a rebound afoot.

And speaking of feet, shoemaking stocks, Nike, Adidas, Wolverine, and my personal pick, Decker's Outdoor, have been among the weaker performers this year. The cutbacks consumers made to keep filling the grocery bags have come at the expense of the low-end consumer discretionary items, like shoes. Add a major hit to margins from a Trump tariff tirade, and you have the recipe for a disaster year for the running shoe makers. People may be wearing smelly shoes, but to me, it smells like a bottom.

The chart below shows signs of selling exhaustion, as indicated by the Chaikin MF indicator. I know it sounds self-serving, but you all should be long Deck!

Deckers Outdoor

So the rotation trade is playing out nicely. Weaker employment, bearish consumer sentiment, and a bit more TACO from the Prince of Pedo should lead to a dovish Fed, creating the conditions for a year-end rally.

That's when the rubber will meet the road.

Risk Model: 2/5 - Risk Off

The surge in pessimism over the AI bubble, combined with a whiff of caution about the Fed, has generated a disproportionate reaction from the sentiment side of the Model. AAII Bull/Bear and $VXV measures are in the 'off' position. But that is what I have been waiting for. The oversold market condition is a good time to position portfolios for the upcoming cyclical trade.

This indicator was useful at the April low. It's close to a buy signal. I'm not waiting for NVDA to report. Tuesday at 11 is here!

S&P 500 % above 50 DMA