Sugar Highs

Tariffs, however sugar-coated, are still tariffs.

If we are seeking to anticipate others' expectations, I guess this stock market rally makes sense. It has made most people wrong, as it often does. Most people, including me, have been skeptical of adding risk in the face of Trump's economic makeover of global trade. Bearishness was at an extreme, setting up a face-ripping bounce that surprised everyone. But is this rally another risk-on, FOMO move destined to fail ultimately?

We won't know until the tariff dust settles sometime later this year, but the 'Art of the Deal' stylebook looks like it is in play here. Bait-and-switch pronouncements have multiplied recently, with Trump now backing off the embargo-level rates on China. Bessent and Co. are shooting for a base level of 10% on all imports. The markets had expected this back-off by bouncing hard off the Independence Day lows. Yesterday's follow-through looks like upside exhaustion to me.

Tariffs are being used to fund a growing fiscal deficit that Congress seems unwilling to tackle anytime soon. Customs receipts alone won't fill the $2tn hole in Washington's wallet, but the market, by rallying, has willingly accepted the down payment. Bond yields have backed up slightly, and stocks have recovered enough to price in a tariff soft landing scenario. Trump's sugar-coated 'deals' with the UK and China have removed the recession tail risk. Anti-Trump groupthink was the crowded trade, and stocks have benefited accordingly.

The focus now shifts to the Fed, which has judiciously navigated Trump's attacks by sitting on its hands. Despite the Administration's badgering and with the bond vigilantes as bodyguards, Powell is now free to tinker with administered rates at his leisure. Should the tariff stagflation and its related consumer confidence hit start to show up in the GDP data in the next few months, rates will adjust downward—a soft landing 2.0 of sorts. Equity bulls will get what they want, despite paying the full-valuation levels that now prevail.

But valuation is rarely a good timing tool. The stock market is expensive but should stay that way until the Fed takes the punchbowl away. That is the lesson of the post-COVID era. The demise of U.S. exceptionalism under Trump was a narrative that drove Eurozone stocks to an overbought extreme in Q1. That is providing the backflow into the U.S. markets now.

I still believe in the sell-in-May theory, though. Even if you remove the threat of economic collapse and replace it with a ham-handed remake of a decades-old supply chain, bad things will still happen. What are the cost implications of reshoring entire industries? We don't know, but they won't be deminimus.

Market earnings expectations and PE ratios are still elevated. Negative estimate revision and surprise environments—as my old friend Rick Pryzbylski taught me—don't always make for happy investors. Despite the ship of fools in Washington having been temporarily righted, there are significant costs to becoming "Great Again." Look for those costs to be unveiled during the upcoming earnings season in late June. A long, hot summer is shaping up for the bulls.

Tariffs are a regressive form of taxation, and their effects will be felt most by those least able to absorb them. Lower employment and weak growth should follow the imposition of any tariff regime. The disruption of an economy hooked on cheap labour and low tariffs is underway. The unknowns abound, and uncertainty won't suddenly disappear with a simple press release. A 90-day period is unrealistically short for developing a line-by-line tariff scheme. And on multiple fronts, no less!

So if you were lucky enough to be trading from the long side recently, I'd cash out for the foreseeable future. Hanging on for the last few upticks here seems foolhardy.

That's not sugar-coated advice, my friend.

Risk Model: 2/5 - Risk Off

The Model seems stuck in the off mode, often in a choppy environment like this. The VXV indicator went positive this week, just as the RSI flashed an overbought 'sell' mode. The AAII Bull/Bear ratio has barely recovered from the shock-and-awe Trump tariff tantrum, and Copper/Gold is still signalling caution.

A mixed bag like this is a trader's market heaven.

Single shots at stocks with tight stops are the way to 'play' this market. More patient investors can stick with Quality as a theme until the economic headwinds pass.

These are the only single shots I'll take over the next two weeks on my Scottish golf trip. I'll see you in a couple of weeks.