Reasons to pull in your horns

There are credible reasons for investors to begin reducing risk in their portfolio.

1. The Fed just started the process of pricking the equity, credit, and real estate bubbles by raising the FFR and reducing the pace of balance sheet expansion. While Mr. Warsh seems to be serious about getting inflation back to 2%, he should be aware that the current increase in prices is only partially attributed to a loose monetary policy. Today’s rising prices are also due to the war in Iran, tariffs, and the debt-fueled AI spending spree. But raising the FFR a few basis points will do nothing in the way of boosting the supply of energy, nor does it rescind tariffs. Therefore, the FOMC will have to raise the FFR aggressively in order to pop the AI investment bubble. Meanwhile, the Fed will be putting more pressure on the already broken middle class. It will be increasing C.C. payments, personal loans, auto loans, and adjustable-rate mortgages, which outside of a brief spike in the fall of 2023, are at the highest level since December of 2000!

Therefore, it should take a long and acute rate hiking campaign to shut off the AI credit boom, which is responsible for 50% of GDP growth and 80% of EPS growth. This means the Fed will once again tip the economy and markets over the cliff, just as it has always done in the past.

2. The bond market is fracturing across the yield curve. While the Fed is hiking the short end, the market has caused the long-end to become unmoored. Upward pressure on yields is coming from:

• Persistent inflation, which has been above the Fed’s target for 6 years
• The nation’s debt and deficits are out of control; debt is 720% of revenue; and annual deficits are $2 trillion and rising
• The BOJ is selling Treasuries to support the floundering Yen. Meanwhile, the Yen carry trade is dissolving
• Our foreign creditors are replacing their dollar currency reserves with gold. In order to do this, they must sell US bonds and dollars to complete the trade. The reasons for eschewing Treasuries are reduced global trade, along with capricious US sanctions and confiscations of foreign assets
• The global anchors of German Bunds and Japanese Government bonds are gone. Bunds and JGBs were near 0% from 2015-2022. But now they are well above 3%–offering stiff competition for US debt and killing the Yen carry trade
• The growth rate of the Fed’s balance sheet has been attenuated. Growing just $30 billion over the past few months instead of the torrid pace of $200 billion during the final 5 months of Jerome Powell’s horrific tenure. Less Fed intervention means more debt must be absorbed by price-sensitive, free-market investors
• There is huge competition for US sovereign debt coming from the half-trillion dollars of AI debt that has been issued so far this year alone

3. High yield spreads have been widening sharply. This is always a bad sign but it is even worse now given that junk bond yields are rising faster than Treasury yields. This is highly unusual because during times of bond market distress bond spreads widen as investors seek the safe haven of Treasuries; just as they also sell junk bonds. But now, both kinds of debt are selling off and that makes it harder for spreads to widen. And yet they are doing so in a big way. For a great example of how this kind of spread widening has been significant in the past and why it has been a crucial component of my Model is what happened last year. Spreads began blowing out in the middle and latter part of February 2025, as insiders dumped junk bonds and ran to the relative safety of Treasury debt. Then on April 2nd President Trump publicly announced his massive Liberation Day tariff levels. The S&P 500 plunged 6% in the next two days. In total, the S&P fell 18% from the end of February to April 9th

4. Market breadth is putrid. While the market is trading near all-time highs, most stocks are not participating at all.

• 72% of S&P 500 companies are down 10% from their 52-week high
• 60% are down 20%
• 40% are down 30% or more

When market participation has been this narrow in the past it has led to sharp selloffs.

Twp quick examples:

• During the Dot-Com Era (1998–2000): Extremely narrow market leadership preceded the eventual collapse of the tech bubble as participation dried up outside a handful of dominant names

• 2022 Correction: Breadth signals deteriorated significantly toward the end of 2021 before the S&P 500 suffered a steep multi-month downturn in 2022.