Welcome back to another Milk Road Macro PRO report.
This is where I take a wide view of the most important factors across the global economy and markets.
We’ll explore what’s happening right now and what might happen next.
We’ve seen weakness across risk asset markets recently.
Many people are wondering:
Is this the end?
Where will markets go next?
Is a long bear market here?
Is the AI bubble popping?
Will a recession happen?
I’ll attempt to give my detailed view on all of these questions.
We will:
- Look in detail at exactly what has happened across markets in the past month
- Discuss what the Fed is up to
- Assess why the dollar is so important
- Look at how financial conditions are shaping up
- Consider where we are in the business cycle
- Take a deep dive into what’s going on with the U.S. economy
- And assess how investors are positioned and what this means
This is a detailed deep dive into the most important factors driving markets.
As always, we have a ridiculous amount of charts to get through (60+).
So, let’s get going…
WHAT IN THE WORLD HAPPENED OVER THE PAST MONTH?
Phase 1 - the pullback
It’s been an odd correction so far through October and November.
On the major index level, we’ve seen S&P 500 -6% and Nasdaq -9%, which is a completely normal pullback, especially considering the excellent performance we’ve seen since April.
But the interesting thing about this small pullback, looking deeper, is that this correction caused a lot of damage in certain pockets of the market.
At one point, 35% of the S&P 500 had entered a bear market (down 20%+).
Also, during the past two months, there’s been a noticeable “rotation out of speculation” - with investors shifting away from more speculative companies and into more defensive/safe haven companies or cyclical companies.
This can be seen through the BUZZ ETF (highly speculative, volatile, retail favorite stocks) relative to the S&P 500 (broad large cap equities) - BUZZ/SPX.
This fell hard through October and November (-22%), more than it did during the big “positioning washout” crash earlier this year in February/March/April.
But it’s now bouncing back - so appetite for speculation may be returning.
This rotation is not massively surprising, given the “sprint to speculation” that occurred between April and September.
I know many people have concerns about bitcoin currently - and there are worries about a fresh year-long bear market.
Here are my thoughts on this.
Some people might not like me saying it, but bitcoin (-36%) is essentially just a speculative high beta U.S. stock - in the eyes of the market.
This is how it has traded for years, and if anything it’s become even more correlated to speculative stocks in the past 18 months or so.
So while this speculation rotation has been occurring, bitcoin has also been hammered, as you would expect based on how it normally behaves.
Here’s a rate of change view of the above chart.
This just looks perfectly normal to me - nothing really out of the ordinary, on a relative basis.
Maybe you could argue bitcoin has slightly overshot where it should be.
But this is just pretty normal price action given the circumstances - so far, at least.
Goldman Sachs head of hedge fund coverage, Tony Pasquariello, wrote:
“I wanted to flag a chart on BTC’s correlations this year. When you trade bitcoin, you’re trading the Goldman Sachs non-profitable tech basket. Fundamentally, both are a bit speculative, cyclical, and share a strong retail bias. This also marks a slight shift from the 2020-2024 period when BTC’s strongest correlation was with 10y breakeven inflation.”
So, in the context of what has been happening across all markets, it’s not that surprising that bitcoin has been hit hard.
However, the big test will be when/if an appetite for speculation returns within the stock market.
If bitcoin does not follow with it (i.e. the long-held correlation breaks down) - it would then be more clear that something has actually changed specifically with the bitcoin/crypto world.
But my base case is that speculation within equities will return - I don’t think this is the start of a long bear market for stocks - and bitcoin will follow with it, as you would expect.
Elsewhere, there’s also been a noticeable unraveling of the “AI trade” in particular, with a lot of AI-linked names underperforming.
There appear to now be some serious concerns brewing over an “AI bubble”.
While I don’t really buy into the narrative that we’re in a “big spooky speculative AI bubble like 1999” (as I outlined in the previous Macro PRO report) - it’s clear that a lot of other people do.
This can be seen through Bank of America’s latest Global Fund Manager Survey.
45% of Fund Managers see an “AI bubble” as the “biggest tail risk” currently.
Some people are starting to worry about the levels of debt being accrued within the AI sphere.
They have been pointing to CDS (Credit Default Swaps) on big-name tech companies (Oracle, Coreweave, Softbank, Amazon, Microsoft, Google) moving higher.
A Credit Default Swap is essentially “insurance” against the default of a borrower.
These Credit Default Swaps are still mostly incredibly low (very low chance of default) - but they are rising on the margin, so it’s something to bear in mind.
However, these AI fears have been met by a formidable opponent - the U.S. government.
The U.S. basically laid out the structure of a national AI strategy last week, as it announced The Genesis Mission.
I think this is important because the language here is very direct - the government appears to have decided on a specific goal and will likely attempt to chase it at all costs.
As many other commentators have noted - AI is now essentially seen as a national security issue as the U.S. races against China for supremacy.
The Genesis Mission appears to be the start of an attempt to “backstop” the AI boom.
Goals include supercharging compute capacity, boosting advanced manufacturing and energy infrastructure, and investing in nuclear and fusion, critical minerals, and the research ecosystem around AI.
Generally, you don’t really want to bet against the government.
Phase 2 - the snapback
But last week, after the pullback, major U.S. equity indices snapped back upwards with a vengeance.
What has been particularly encouraging about this recent recovery is the impressive breadth.
I’ve outlined previously how the equity rally in recent months had started to become “narrow” (fueled by a relatively small number of names).
This can be an unhealthy sign and a potential signal of an exhausted bull rally “running on fumes”.
But in recent days we’ve seen a very healthy rebound, with widespread participation.
This kind of “broadening out” is typically a sign of strong underlying tailwinds.
Below, you can see an index showing whether 8 “risk sensitive” sectors* are in a bullish or bearish trend.
(*Semiconductors, small-caps, transports, biotech, homebuilders, banks, retail, steel.)
It had been breaking down through October and November and briefly hit 3, but last week it instantly snapped back to 8 (all 8 sectors bullish trend).
This is typically a sign of a “healthy market” and not what you would expect to see at a major top.
It was almost like the small pullback suddenly jolted the whole market back into action.
The price action we saw across the whole U.S. equities space last week can be labeled a “breadth thrust”.
This signals a sudden shift from weak market participation to strong market participation.
It’s a fast, sharp improvement - not a slow, steady climb - and shows buyers are suddenly stepping in across the whole market, not just a few big stocks.
There are various ways of measuring these “breadth thrusts”.
But it’s clear that what we saw last week is a bullish signal historically.
We didn’t quite meet the criteria for a “Zweig Breadth Thrust” - which is the gold standard of breadth thrusts - but we got pretty close.
Even an “almost Zweig Breadth Thrust” is pretty good though.
Obviously, no one signal is perfect - but the breadth seen recently has definitely been notable.
The Russell 2000 (small cap U.S. stocks) has also been performing well (outperforming the S&P 500) and is threatening to break out to new multi-year highs after essentially trading flat for 5 years.
This is a very important signal to watch - a strong Russell 2000 break-out is a sign of a healthy economy and an upturn in the business cycle (the Russell basically is the business cycle in equity form).
Continued rate cuts from the Federal Reserve are good news for the Russell 2000, which includes smaller companies that are more sensitive to changes in interest rates relative to mega-caps.
I’ve mentioned before how the long-term Russell 2000 chart is almost identical to the Ethereum chart.
Ethereum is now lagging behind big time.
You would expect Ethereum to catch up, should the Russell 2000 break out and move strongly higher.
However, if it doesn’t - this is a big red flag.
All previous major Russell 2000 break-outs (2020/2021, 2017 and 2013) coincided with crypto “frenzy phases”.
Consensus expectations put 2026 EPS (earnings per share) growth for the Russell 2000 at nearly 50% - which is massive.
The Russell is still recovering from two years of negative EPS growth in 2023 and 2024, and you could make the argument that some of the fiscal policies put in place by the Trump administration will help small caps.
The caveat is that consensus expected a similarly strong rebound for 2025 EPS growth and that has not been realized.
WHAT’S GOING ON WITH THE FED?
I mentioned previously that the Federal Reserve’s “running it hot” policy (cutting rates into a resilient economy) is probably the most important thing to watch.
It’s a big factor powering asset markets higher - but I said that if the expected cuts did not transpire, markets would likely throw a tantrum.
This is what happened recently, with December rate cut odds sliding from more than 90% to less than 35% between late October and late November.
They’ve since rebounded to more than 80% again - after New York Fed President John Williams said he “sees room” for a rate cut “in the near term”.
During this time, risk assets have traded in almost perfect lockstep with December rate cut odds.
Looking ahead, we may now know who the next Chair of the Federal Reserve is, as current Fed Chair Jerome Powell is set to finish his term in May 2026.
Kevin Hassett has emerged as the clear frontrunner for the job.
I explained here why, if appointed, Hassett is set to be extremely dovish and is likely to want to lower rates, potentially quickly (whether he’ll be able to or not is another question - he needs consensus from the 12-person FOMC board).
This is simply a further extension of the “running it hot” thesis.
As long as the economy continues to remain resilient (this is important), and a new “uber-dove” Fed Chair is arriving - the “run it hot” narrative will remain.
This is what markets will expect and look ahead to.
Currently, the market is expecting roughly four 25bps cuts between now and the end of 2026 - so three cuts in 2026, if we assume there will be a cut in December.
So the market isn’t expecting “rapid turbo rate cuts” - but there are a meaningful number of cuts expected.
The risk here is that, for whatever reason, this expected future dovishness doesn’t transpire.
If that happens, I think we might see a much larger tantrum from risk asset markets.
One advantage that the Fed has is expectations of future inflation have been dropping hard in recent weeks.
Inflation swaps (market-derived expectations of future inflation) have been falling.
This implies that the market believes there is a disinflationary impulse emerging, and this could allow Fed members to be more dovish on interest rates without unleashing unwanted inflationary pressures.
This is a big change in the past two months or so - after inflation expectations generally rose through most of 2025.
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WHAT’S LEFT INSIDE? 👀
- Why the dollar is vitally important for what happens next
- How financial conditions can shape the investing landscape
- Where we are in the business cycle and why that matters
- Assessing the strength of the U.S. economy and how short-term shifts can have big impacts
- How investors are currently positioned and what we can learn from how they’ve reacted to recent events
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