The Supreme Court (SCOTUS) will begin hearing arguments challenging President Trumpโs use of tariffs. Given the market volatility that tariffs have generated over the last six months, the SCOTUS case could prove to be yet another market-moving event. The tariff challengers argue that the administration overstepped its bounds under the 1977 International Emergency Economic Powers Act (IEEPA) by invoking vague “national emergencies” related to trade deficits, fentanyl trafficking, and geopolitical leverage to justify tariffs. Lower courts, including the U.S. Court of International Trade and the Federal Circuit Court of Appeals, have ruled against the administration. Generally, they deem that the tariffs are not a genuine response to โunusual and extraordinary threats,โ as the President claims. The phrasing โunusual and extraordinary threatsโ is from the IEEPA. Given that the lower courts do not believe the tariffs are appropriate, they hold that Congress is the only branch of government authorized to tax.
If the tariffs remain in place, the market reaction may be minimal. If they are repealed, some of the lagging sectors, such as consumer staples and autos, may benefit. Personal consumption has been weakening due to the minimal labor market growth, poor sentiment, and inflation. Tariff removal could improve inflation-related sentiment and potentially restore job growth. Exporters may struggle as the market perceives that the US has less leverage to force our products into foreign markets. Similarly, sectors shielded from foreign competition, such as steel and aluminum producers, could slump on such news. Treasury bonds could see yields rise as the government faces a larger deficit, since tariff revenue, estimated at over $2 trillion over the next decade, will vanish. The graph below charts the federal tax revenues expected by the Urban-Brookings Tax Policy Center over the next ten years.
What To Watch Today
Earnings
Economy
Market Trading Update
Yesterday, we discussed the market’s 6-month advance, which, although historically long, tends to lead to further gains. As we noted, this is particularly the case as we head into the two strongest months of the year.
However, there are also concerns with that outlook, particularly when there are indications of a breakage of internal momentum in the market. As shown in the first chart below, despite the market still being near all-time highs, the number of stocks on “bullish buy signals” is deteriorating rapidly. Just FYI, you saw the same thing heading into the “Liberation Day” sell-off in April.
Furthermore, as we have noted over the past few days, the percentage of stocks trading above their respective 50- and 200-day moving averages continues to decline, even though the market remains elevated. That negative divergence (rising stocks and declining breadth) tends to precede market corrections.
Lastly, relative strength is also negatively diverging from the rising market. On a weekly basis, the market is extremely overbought, with momentum at its highest level ever recorded. Previous downturns from such extreme readings were rather severe in both 2022 and during the April sell-off this year.
While none of this suggests the market is about to crash and that you should “sell everything and go to cash,” it does mean investors should use some caution. What eventually causes a more severe correction is unknown. But that is always the case and why investors get trapped in the “unexpected” event.
It does you little harm to “carry an umbrella” even if you don’t expect it to rain. Sure, people may laugh at you while the sun is shining, but when an unexpected shower arises, they will pay you money for that little bit of protection.
Palantir: Good Earnings But Bad Market Reaction
On Monday night, Palantir reported stellar earnings with EPS and revenue easily beating estimates. Further, Palantir raised its full-year revenue and free cash flow guidance. The graphic below shows the earnings and revenue beats alongside the raised guidance.
Despite the great earnings report, Palantir’s stock opened down by nearly 8%. It appears that investors are grappling with the company’s sky-high valuations. Consider that Palantir trades at a Price-to-Forward Earnings ratio over 200 and a Price-to-Sales ratio over 125. Moreover, its PEG ratio, which incorporates almost 50% annual earnings growth for the next five years, is extremely high at 13.60. For further consideration, the stock was up 3x for the year and has risen from $6.50 at the start of 2023 to just under $200. All of this is another way of saying that incredible earnings growth is already priced into the stock. It’s likely that some traders are using the earnings to take profits.
The takeaway is that fundamentals always matter, but they are often ignored during speculative periods.
Preparing For The Next Rotation
Market breadth stinks. This is no secret, as we and many others have detailed in numerous examples. However, what is much less known is what will cause the market breadth to improve. By definition, when breadth improves, the large number of lagging stocks, sectors, and factors should outperform the tech-heavy S&P 500 and Nasdaq, especially the few leading stocks.
SimpleVisor can help identify which stock sectors and factors might benefit from a rotation that supports better breadth. The table below lists stock sector pairs with a correlation of 0.60 or higher in their excess returns. In other words, it seeks two sectors that are simultaneously over- and underperforming the market consistently. We highlight the technology/financials (XLK: XLF) combination. The correlation of its excess returns is .61. Equally significant, over the last 21, 63, and 252 trading days, the divergence of excess returns between the pair is near the lowest percentile. Bottom line, when breadth improves, it’s highly likely that financials will outperform the technology sector. Also shown are the staples, healthcare, and real estate sectors, with similar possibilities.
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