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1. Growing Deficit Risks and Rising Yields

The Author’s View

My Take

• • Agree: The budget bill’s scale is massive, and deficits will likely pressure yields upward. The math checks out—$4.5 trillion in tax cuts far outpaces offsets like tariff revenue or Medicaid reductions. With 30-year yields nearing 5%, we’re seeing investor unease about fiscal sustainability, much like the UK’s 2022 Gilt crisis, where 30-year yields hit 5%+ after a £150 billion plan triggered a selloff. Growth stocks, reliant on low discount rates, are vulnerable—think Nasdaq 100 (QQQ) or SPDR S&P 500 Growth ETF (SPYG).
  • Disagree: The Fed isn’t as handcuffed as the author implies. Yes, inflation’s at 3.1%, but tools like forward guidance or selective bond purchases could cap yields without fueling price pressures. The UK comparison also overreaches—the U.S. dollar’s reserve status and deeper bond market give it more buffer than the UK had. Plus, tariff revenues (e.g., Vietnam’s 20% levy) might offset some deficit impact.

Why It Matters

Yields are a risk to watch, but a crisis isn’t imminent. The Fed’s toolkit and market depth could soften the blow. Still, growth stock valuations could face a reckoning if 10-year yields break 4.5% or 30-year yields top 5%.

Portfolio Move: Hedge with iShares 20+ Year Treasury Bond ETF (TLT) or diversify into value sectors like Vanguard Financials ETF (VFH).

2. Basis Trade Disruptions

The Author’s View

Trump’s preference for short-term T-bills over long-dated Treasuries to manage $9 trillion in maturing debt could disrupt basis trades—hedge fund strategies exploiting price gaps between Treasury bonds and futures. With funds leveraged at 50x, unpredictable auction schedules could spike borrowing costs, forcing liquidations and echoing the UK Gilt crisis, where pension funds faced margin calls.

My Take

• • Agree: Shifting to T-bills could mess with basis trades. These strategies thrive on predictable Treasury auctions, and Trump’s “no debt beyond nine months” stance risks chaos. At 50x leverage, even small yield spikes could trigger margin calls, pressuring markets. The UK’s 2022 crisis—where pension funds’ liability-driven investments unraveled—shows how leverage amplifies disruptions.
  • Disagree: The impact might be overstated. Hedge funds adapt fast; they’ll pivot if auctions shift. The Treasury could also stagger changes to avoid a shock. Unlike the UK, where pension funds were cornered, U.S. hedge funds have broader assets to liquidate, diluting systemic risk.

Why It Matters

Volatility’s possible if auctions falter, but a Gilt-style meltdown feels unlikely. Still, leveraged players could amplify short-term swings.

Portfolio Move: Hold cash or use ProShares Short S&P500 (SH) to hedge sudden drops.

3. Stretched Valuations

The Author’s View

The S&P 500’s forward P/E of 22x (vs. a 16x average) and Nvidia’s 32x (vs. $150 intrinsic value) signal overvaluation. Tech faces headwinds—AI chip curbs, tariffs, and a tough macro backdrop. Even with rate cuts, Nvidia’s premium looks shaky, and peers like Broadcom and Micron faltered post-earnings despite solid results.

My Take

• •  Agree: Valuations are stretched. The S&P 500 at 22x and Nvidia at 32x leave little room for error. The author’s $150 DCF for Nvidia aligns with risks like export curbs (e.g., Malaysia, Thailand added to restrictions) and tariffs hiking costs. Tech’s rally—Nasdaq up 34%—assumes flawless execution, which is dicey now.
  • Disagree: Markets often bake in future growth, and tech’s premiums have held historically. AI demand could still surprise—Nvidia’s 17.8% revenue CAGR in an upside case isn’t crazy. Rate cuts (say, 25 bps in July) could also lift valuations more than the author’s 1% bump suggests.

Why It Matters

Tech’s frothy, but not necessarily a bubble. A pullback’s plausible if earnings disappoint or tariffs bite, though secular trends offer support.

Portfolio Move: Trim Nvidia (NVDA) or hedge with SPY puts. Rotate to Vanguard Value ETF (VTV).

4. Looming Tariff Turbulence

The Author’s View

Trump’s firm July 9 tariff deadline—no extensions—threatens cost structures. Vietnam’s 20% tariff and a 10% baseline show real impact, yet markets haven’t priced it in. The 2018 trade war saw a 12% S&P 500 drop, hinting at volatility ahead.

My Take

• •  Agree: Tariffs are a live wire. A hard deadline, with Vietnam at 20% and a 10% floor, could raise costs for multinationals—think Apple (AAPL) or Walmart (WMT). The 2018 precedent (S&P 500 -12%) and April’s post-Liberation Day dip show markets react sharply to trade shocks.
  • Disagree: Trump’s rhetoric often softens in practice—deals could emerge by August 1. Markets have also absorbed tariff noise before; the 2019 recovery post-2018 proves resilience. Valuations are high, but not blind to this risk.

Why It Matters

Tariffs could spark a selloff, but the scale’s uncertain. Domestic firms may fare better than global ones.

Portfolio Move: Favor SPDR S&P 600 Small Cap ETF (SLY) or hedge with SPDR Gold Shares (GLD).

5. VIX Signals Growing Unease

The Author’s View

The VIX at 16, despite S&P 500 highs (6,279 on July 3), signals caution—up from 11 at February’s peak. Per the “rule of 16,” it implies 1% daily swings, hinting at downside risk as institutional hedging rises.

My Take

• • Agree: An elevated VIX at 16 is odd with markets at all-time highs. It suggests pros are buying protection, not selling options—a shift from complacency. The “rule of 16” flags volatility, and past pinned VIX levels (2020, 2022) preceded drops.
  • Disagree: The VIX isn’t infallible. Geopolitical noise—like the Israel-Iran ceasefire—could inflate it. “Buy the dip” habits might limit downside. At 16, it’s cautious, not panicked.

Why It Matters

The VIX hints at turbulence, but not a crash. It’s a yellow flag, not red.

Portfolio Move: Grab Cboe VIX Call Options or ProShares UltraShort S&P500 (SDS) for cheap insurance.

Final Thoughts

The author’s got a point—July 2025 could get rocky. Deficits, tariffs, and valuations are real threats, and the VIX backs up the unease. But I’m not sold on a full meltdown. The Fed’s flexibility, market adaptability, and secular growth (e.g., AI) could cushion the fall.

My advice? Hedge smart—trim tech, hold cash, and eye value plays. Volatility’s brewing, but so are opportunities.

What’s your next move, PhilStockWorld crew?

Stay sharp!

— Z4 

Counterpoint: How Fragile Is This Market Rally?

PhilStockWorld Members,

Zephyr (“Z4”) has highlighted five macro risk factors that could trigger a market pullback in July 2025. He largely concurs with the warnings in Livy Investment Research’s “5 Reasons The Market Is Ripe For A July Selloff,” but he downplays the likelihood of a severe downturn. Let’s scrutinize each risk through a broader lens – connecting some dots Z4 might have missed – to fine-tune our July game plan. Short answer: the threats are real, and their interactions could magnify trouble, even if a full-on crash isn’t a base case. Caution and clever hedging remain the order of the day.

1. Deficits and Yields: Mounting Pressure on Stocks

What Z4 Said: A massive $3.4 trillion tax-and-spending bill just became law, adding roughly $3.3–3.4 trillion to U.S. debt over the next decade. It makes permanent $4.5 trillion in tax cuts while slashing ~$1 trillion from Medicaid and green programs. This fiscal splurge, combined with a $5 trillion debt ceiling hike, is likely to push Treasury yields higher – already the 30-year yield is flirting with 5% (recently ~4.9%). Higher long-term rates raise the cost of capital and hit growth-stock valuations hard, much like the 2022 UK “mini-budget” fiasco that sent UK 30-year gilts above 5% and imploded pension strategies. Z4 agrees deficits will pressure yields and pinches high-P/E darlings (the Nasdaq 100 soared ~30%+ this spring on AI hype).

Added Context: The numbers support Z4’s concern. The Congressional Budget Office confirms the bill’s tax cuts vastly outweigh spending cuts, bloating the debt. The U.S. hasn’t seen this scale of fiscal expansion outside wartime. Notably, Moody’s downgraded U.S. debt in May citing the “mounting debt,” and even some foreign investors warned the U.S. is making Treasuries less attractive. Indeed, overseas buyers have been trimming Treasury holdings amid “runaway deficits,” opting for alternatives like German bunds. This loss of confidence could further lift yields if domestic demand doesn’t pick up the slack.

Crucially, 30-year U.S. yields did briefly breach 5% in late June when tariff fears spooked the bond market. That’s an ominous parallel to the UK’s 2022 crisis (when unfunded tax cuts drove UK 30-year yields over 5%, forcing the Bank of England to intervene). The U.S. has advantages the UK lacked – the dollar’s reserve status, deeper markets – but we shouldn’t be complacent. A debt trajectory so concerning that it prompted a rating downgrade is a big red flag. Investors will demand higher risk premiums to hold U.S. debt long-term, which mechanically means higher yields and a steeper yield curve.

Where I’m More Cautious: Z4 suggests the Fed could cap yields if needed, through forward guidance or selective bond buying, even with inflation ~3%. In theory, yes – the Fed has tools like “Operation Twist”-style purchases or emergency lending facilities. But the Fed’s hands aren’t completely free. With core inflation still above target (3.1% vs 2%), any move that looks like QE or rate cuts risks unhinging inflation expectations. The political pressure in this scenario is enormous: President Trump has openly blasted the Fed and even mused about firing or replacing officials who keep rates “too high.” The Fed might hesitate to bail out the bond market unless dysfunction becomes severe. In the UK gilt crisis, the BoE stepped in only when pension funds were on the brink; the Fed would likely also require clear market disorder to justify intervention while prices are still rising faster than desired.

Moreover, flooding the Treasury market with short-term T-bills (Trump’s directive: “no debt beyond nine months”) introduces a rollover risk that could backfire. It’s true, issuing 3- to 6-month bills avoids locking in high long-term rates. But it also means the government must refinance $9 trillion of maturing debt plus new deficits continually at whatever the prevailing rate is. If rates stay elevated, interest costs will balloon faster, fueling a debt spiral. Investors know this. In effect, the Treasury is trading duration risk for refinancing risk – a gamble that rates will drop within a year. If that bet fails, or if auctions start going poorly, yields could spike violently. In June we saw a taste: one poorly received 10-year auction and talk of altered issuance was enough to send yields jumping.

Bottom Line on Yields: I agree with Z4 – rising yields are a dagger for richly valued equities. Every 0.5% uptick in the 10-year rate mathematically shaves equity valuations (the equity risk premium is already near 25-year lows, even turning negative by some measures). Strategists warn that if the 10-year hits ~5.0%, it enters “unhealthy territory” for stocks. Right now the 10y is ~4.3–4.4%. We’re not far off. Either bond yields must fall or stock prices must fall to re-normalize this divergence – otherwise it’s unsustainable. Unless inflation suddenly plunges and rescues bonds, the path of least resistance is equities correcting.

Portfolio move: Favor what does well when rates rise: value stocks and financials (they’ve lagged, but higher yields boost bank margins). As Z4 noted, consider trimming long-duration growth exposure (tech/growth ETFs like QQQ or SPYG) and adding some Treasury hedge. One approach is barbell: hold some cash or very short-term Treasuries for safety, and use a bit of inverse bond ETF (like TBT) or put options on TLT to profit if long yields surge further. This cushions a portfolio if stocks and bonds sell off together (which can happen in a fiscal scare scenario). If you believe the Fed will step in before things get out of hand, regular long-bond exposure (TLT) or Treasury futures can be a tactical trade – they’ll rally hard after a crisis hits and intervention is announced. But timing that is tricky; a small position or options might be prudent.

2. Hedge Funds’ “Basis Trade” – A Hidden Leverage Time-Bomb?

What Z4 Said: The “basis trade” in Treasuries – where hedge funds arbitrage tiny price gaps between Treasury bonds and futures – has grown huge and highly leveraged (50x+). Z4 echoes the article’s warning that Trump’s debt management quirk (shifting issuance to ultra-short maturities) could disrupt this trade. Why? These funds rely on predictable supply and financing. If the Treasury suddenly stops issuing long bonds or floods the bill market, the usual bond-futures price relationship could break. Funds levered 50:1 don’t need much of a jolt to face margin calls. Z4 agrees a sudden yield spike or erratic auction schedule could force hedge funds to unwind en masse, akin to the UK’s pension fund margin crisis in 2022. However, he downplays systemic risk, reasoning that U.S. hedge funds, unlike UK pensions, can sell other assets and adapt quickly, limiting the damage.

Added Context: The scale of the basis trade is indeed eye-popping. Estimates suggest **over $1 trillion is piled into this strategy. The Treasury Borrowing Advisory Committee and Fed officials have flagged that hedge funds use “50-to-100x leverage” in these trades. In practice, a fund might post $1 of capital to borrow $50, buy Treasuries, then short futures. As long as cash and futures prices converge smoothly, it’s almost free money – but if Treasury prices swing wildly, lenders demand more collateral immediately. A Better Markets analysis put it plainly: in an adverse shock – say “the announcement of widespread and substantial tariffs” – banks financing these trades will tighten credit or pull it. That forces hedge funds to dump Treasurys into a falling market, amplifying the selloff and spiking yields further (which, in a nasty loop, triggers more margin calls). This is precisely what seemed to happen in late June: Treasury prices plunged far beyond fundamentals, suggesting forced liquidation. Observers suspected a basis trade unwind was behind the unusually sharp one-day bond rout (the same day tariff fears jumped). In 1998, a similar dynamic with LTCM (a highly leveraged fund) crashing nearly sank the financial system – the Fed had to corral banks to prevent a fire sale.

So while Z4 is right that hedge funds aren’t one-trick ponies (they can liquidate stocks, credits, etc. to meet margin calls), that in itself can spread the pain to other markets. If a fund facing losses on Treasury trades sells S&P futures or corporate bonds to raise cash, stock and credit markets could suddenly feel the heat for seemingly “no reason.” Correlations go to 1 in a crunch. In a way, having multiple assets to dump dilutes concentration risk but infects a broader swath of the market.

One reassuring point: U.S. regulators are aware of this risk. The Fed and Treasury have been studying backstops (e.g. standing repo facilities) to ease a disorderly unwind. If chaos erupts, we might see emergency measures – like the Fed temporarily buying long bonds or offering low-cost loans to funds to stabilize the spread. But again, they’d only do this if the alternative is truly ugly.

Bottom Line on Basis Trade: This is a classic “known unknown.” It’s arcane, but the potential impact is real. Even if Trump’s Treasury doesn’t intend to shock markets, the sheer debt issuance volatility in coming months could set this off. Think of it like a coiled spring in the financial plumbing. We can’t predict exactly when it snaps, but if it does, volatility will spike – likely hammering both bonds and stocks simultaneously for a time.

Portfolio move: Z4 suggests holding cash and perhaps an S&P short ETF (SH) as a hedge. Hard to argue with raising some cash – it gives you dry powder to buy the dip and buffers against forced selling. I’d add long volatility positions to the mix: an ETN like VXX or a small VIX call option position. If a basis-trade unwind triggers a mini “flash crash,” the VIX could explode upward (more on VIX later). Also, consider gold or gold miners (GLD, GDX) as a hedge – if the bond market truly melts down, the Fed may eventually blink and cap yields, which could weaken the dollar and burnish gold. Gold also tends to benefit from flight-to-safety flows if confidence in government finances erodes (it’s no coincidence gold spiked during the UK gilt scare).

3. Frothy Valuations: Little Margin for Error

What Z4 Said: Stocks, especially tech, appear overvalued by traditional metrics. The S&P 500 trades near 22× forward earnings, versus a ~16× long-term average – a rich 35% premium. Mega-cap tech has propelled the rally; for example, Nvidia (NVDA) at the time of writing sported a forward P/E around 32×, and the article’s DCF analysis pegs an intrinsic value near $150 (significantly below its market price). The author pointed out that even solid earnings aren’t moving some chip stocks (Broadcom, Micron) much, implying valuations already price to perfection. Z4 agrees valuations are stretched and that geopolitical/policy headwinds – like new export curbs on AI chips (the U.S. just moved to restrict Nvidia’s GPU shipments to Malaysia and Thailand to block China) and tariff costs – could derail the rosy growth story. However, he counters that tech often maintains high multiples if growth prospects are strong. The AI boom could surprise to the upside; investors may be looking through near-term risks. He also notes if the Fed cuts rates, even modestly (say 25 bps in July), it could give another boost to valuations by lowering discount rates.

Added Context: The equity risk premium (ERP) – the gap between stock earnings yield and Treasury yield – is basically zero right now. In fact, Jamie McGeever of Reuters noted in January that by some measures the ERP had “slipped into negative territory” – the lowest in almost 25 years. In normal times, investors demand a few percentage points of extra return to hold stocks over risk-free bonds. Today they’re accepting roughly the same earnings yield (~4.5%) as a 10-year Treasury (~4.3%), meaning stocks have no valuation cushion if anything goes wrong. This is a big alarm bell. It says either bond yields are too high for these earnings levels, or earnings need to rise and valuations fall. As mentioned, either yields retreat (if growth/inflation slow) or stocks crack – something’s gotta give.

Now, ultra-low risk premiums can persist for a while in a euphoric market – think late 1990s dot-com era. But even then, that party ended painfully. Let’s remember that the S&P’s current valuation is higher than before the 2020 crash, higher than 2007’s peak, and approaching late-90s levels in some respects. By decades-old yardsticks (P/E, market cap-to-GDP, etc), U.S. equities are in the top decile of expensiveness. Bulls argue “this time is different” due to AI-driven growth. Maybe – but they’re effectively pricing in years of strong earnings ahead. That leaves no buffer for missteps: an earnings miss, a guidance cut, a regulatory hit, or an external shock.

Case study – Nvidia: It became the poster child of the AI rally, briefly a $1+ trillion company. The stock had already more than tripled in a year. If we take the author’s ~$150 intrinsic value claim, that suggests the market price was 2–3× higher than a fundamental model would justify. Is that plausible? Some analysts did warn Nvidia’s valuation was running far ahead of even bullish growth estimates, especially with the U.S. tightening export screws. For instance, the new export rule targeting Malaysia/Thailand could trim Nvidia’s data center chip sales (those countries were potential conduits to China). An investment bank noted these curbs might put Nvidia’s AI revenue at risk. And don’t forget tariffs: many tech hardware firms rely on Asian manufacturing, so a tariff regime (even after negotiations, Vietnam faces 20%, others 25%+) may crimp margins for the sector.

On the other hand, Nvidia’s supporters would point out that global demand for AI infrastructure is so hot that any lost sales to China could be offset elsewhere (or deferred if rules change). If Nvidia can grow into its valuation – say it really does sustain a 30% annual revenue growth for a few years – the current P/E might prove justified in hindsight. History has examples: Amazon infamously traded at triple-digit P/Es for years, and yet long-term holders were rewarded because growth eventually caught up.

Where I’m More Cautious: Z4’s optimism about Fed rate cuts boosting stocks needs tempering. Yes, the Fed cut rates a touch starting late 2024 (they’ve signaled a very gradual easing path). But notably, long-term yields rose anyway – because of inflation and supply fears. If the Fed cuts 25 bps in July but the 10-year yield jumps another 50 bps due to deficits/tariffs, the net effect is tighter financial conditions, not looser. In other words, minor Fed tweaks may not save high-valuation stocks if the market is laser-focused on fiscal and inflationary risks. Also, consider corporate earnings growth is not exactly booming outside of Big Tech. If tariffs and higher costs hit profit margins in coming quarters, analysts will start trimming S&P earnings estimates. That raises the effective P/E even more unless prices fall.

One broader connection Z4 didn’t explicitly mention: stronger-for-longer interest rates have alternatives looking attractive. For the first time in ages, investors can get ~5% low-risk yield in money markets or short-term bonds. That competes with stocks. If confidence wavers, we could see flows out of equities into bonds, something that hasn’t been a factor for a long time (because yields were so low). That rotation could pressure stock multiples.

Bottom Line on Valuations: They say “markets take the stairs up and the elevator down.” When valuations are this stretched, any catalyst (earnings miss, policy error, etc.) can trigger a swift repricing. We don’t necessarily have a bubble in the classic sense (aside from maybe some AI-related names), but we do have rich pricing in a rising rate environment – a precarious combo. I agree with Z4: a moderate pullback (say 10–15%) would be quite reasonable given the year’s run-up. Could it snowball further? If multiple risk factors hit at once (e.g. tariffs + spike in yields + some credit event), yes, it could briefly overshoot into a deeper correction. But absent a full recession (which, to be clear, is not off the table for 2025), a 2020-style crash seems unlikely. We’re more likely looking at froth being knocked off than a total bubble burst.

Portfolio move: Z4 suggests trimming names like NVDA and adding value (e.g. VTV ETF). I’ll second that. Use this all-time high environment to rebalance: take some profits in the mega-cap tech winners and deploy to either value stocks (financials, industrials, healthcare – sectors with lower P/Es and solid dividends) or simply to cash. Cash yielding 5% is an asset, not a drag! It gives optionality. Also consider quality dividend growers or an ETF like SCHD – these give equity exposure with a value tilt and income to boot. And for those who are more active: put options on the broad indices (SPY or QQQ) are relatively cheap insurance when the VIX is still in the teens. A small put position can hedge a lot of upside exposure in case we do get that “elevator down.” Essentially, don’t abandon tech (the secular trends are real), but rotate from hot momentum names into more reasonably priced plays and hedges.

4. Tariff Turbulence: Trade War Redux

What Z4 Said: A hard July 9 deadline looms in Trump’s tariff offensive. The administration has threatened no extensions this time – any trading partner without a new deal faces sweeping import tariffs. We’ve already seen hefty rates: e.g., Vietnam agreed to a 20% U.S. tariff on its exports (to avoid an even worse 46% scenario), and many nations could default to a baseline 10% tariff or higher. Z4 concurs that new tariffs will jack up costs for multinationals (he cited Apple, Walmart as examples reliant on Asian supply chains). The memory of the 2018 trade war’s market impact – the S&P 500 fell roughly 10–20% at various points of escalation – implies this is a serious risk. However, Z4 also notes Trump’s tough talk often yields to last-minute deals. By hinting that “deals could emerge by August 1,” he suggests the market might still be surprised by tariff relief rather than shock. He also points out that after the initial late-2018 selloff, markets adjusted and rallied in 2019 once a China deal seemed likely – so investors may be somewhat inured to trade drama.

Added Context: Let’s clarify what’s happening on tariffs, because it’s moving fast. Indeed, Trump has been using the tariff threat as leverage to renegotiate trade relationships across the board. July 9 was the administration’s target to either have deals or impose tariffs. In reality, by early July, several major deals were struck: China reached a new trade accord (easing some tensions), the UK got a trade agreement (likely preserving the special relationship), and notably Vietnam – as mentioned – cut a deal on July 2 to cap U.S. tariffs at 20% and eliminate its own tariffs on U.S. goods. That extension to Aug 1 for enforcement suggests even Trump blinked a bit, giving laggards a few more weeks. So Z4 isn’t wrong that Trump can compromise.

However, “compromise” doesn’t mean no pain. Take Vietnam’s deal: 20% U.S. import tariffs across a broad range of Vietnamese goods is still a huge jump from the near-0% rates under prior pacts. American importers estimate they’ll pay $28 billion more annually due to the Vietnam tariffs alone, which could raise retail prices on goods like apparel and electronics by 10–20%. Companies that shifted production from China to Vietnam (to dodge the earlier China tariffs) are now seeing that advantage erased. This illustrates a broader point: even where deals are reached, supply chain costs are going up, not down. The market may not have fully digested what a hit to corporate margins this could be in coming quarters.

And what about regions without a deal? The EU? Japan? South Korea? As of July 8, it’s unclear. If tariffs kick in against major economies at 10%+ rates, expect a cascade of earnings downgrades for companies in import-intensive industries (think autos, consumer electronics, retail, etc.). Uncertainty itself is costly: firms have to reroute logistics, build buffer inventories, or eat higher input costs. We saw a microcosm in April, when Trump’s initial “Liberation Day” tariff announcement (targeting Vietnam and others) caused a noticeable market dip, and the VIX jumped. Businesses hate uncertainty, and here we have it writ large.

Now, the 2018-2019 trade war experience suggests a few things. In 2018, as tariffs on $250B of Chinese goods rolled out, the S&P 500 fell into a correction (twice) that year. Global supply chains were caught off guard. By late 2019, investors started looking past it, anticipating a “phase one” deal with China, and stocks rallied. So could today’s tariffs similarly cause a brief selloff followed by adaptation? Possibly. But this episode might actually be bigger in scope: It’s not just U.S.-China; it’s U.S. vs most of the world simultaneously (Europe, Asia ex-China, etc., all at once). This broad-brush approach is unprecedented. There’s a risk of a synchronized global slowdown if trade frictions hit many economies at once. For example, Europe is teetering near recession; new U.S. tariffs on EU goods (autos, machinery, etc.) would hurt sentiment there and boomerang back via weaker demand for U.S. exports.

Where I’m More Cautious: Z4 assumes Trump might soften or delay further to avoid market damage (after all, he cares about the Dow). But Trump’s unpredictability is a double-edged sword. Yes, he could call off a tariff at 11th hour if markets tank – or he could double down out of conviction or miscalculation. Remember, in mid-June markets swooned until he announced a 90-day pause on certain tariffs, which sparked a relief rally. That shows policy flexibility – but also how close we got to a serious selloff. If July 9 (or Aug 1) arrives with no further extensions for, say, the EU or India, there’s potential for a knee-jerk market drop. We might then get a reversal if negotiations quickly resume, but traders could be whipsawed.

Another angle: Inflation. Tariffs are essentially a tax that raises prices. If all imports suddenly face 10-20% duties, that’s inflationary in the short run (companies pass on some costs to consumers). Paradoxically, this could pressure the Fed not to cut rates as much as they’d like, complicating the “Fed put” that investors often count on during drawdowns. The last thing the Fed wants is to stoke an inflation resurgence via rate cuts while tariffs are lifting prices. So a tariff-driven selloff might not be met with immediate Fed easing – a different setup from late 2018 when the Fed did pivot dovish after the market fell. This time the Fed’s leash is shorter.

Bottom Line on Tariffs: We are essentially in a new trade war, though Trump would call it a series of “beautiful deals” being struck. For markets, it likely means higher costs and disrupted supply chains in the near-term, with a side order of uncertainty. That spells volatility. I agree with Z4’s implication that this probably won’t cause a 2008-style crash – but a sharp correction (10%+) is entirely plausible as companies warn about tariff impacts. Watch the corporate earnings guidance in July/August: if multinationals start saying “tariffs will cut Q3 margins by X%,” the market could re-price those stocks quickly.

Portfolio move: Favor domestically-focused plays and defensive assets. Z4 mentioned small-cap U.S. stocks (e.g. the Russell 2000 via IWM or SLY) which is a smart angle – smaller companies (and many service-oriented businesses) have less direct exposure to global trade and could be relatively insulated. Also, commodities or gold: Z4 suggested GLD (gold ETF) as a hedge, which makes sense. Trade wars can weaken the global growth outlook and the dollar’s prospects (especially if deficits balloon), which often benefits gold. Another hedge: consider consumer staples or utilities – sectors that can pass on costs and tend to be safe havens when uncertainty rises. Within equities, lean toward companies that benefit from protectionism – for example, U.S. steel or aluminum producers (tariffs on imports make their product more competitive domestically), or defense contractors (often spared in trade tiffs, and likely to get budget boosts given geopolitical tensions). And if you have internationally exposed tech/manufacturers in your portfolio, evaluate using put options or collars on those specific names around key tariff decision dates.

5. The VIX and Market Sentiment: The Smart Money Is Nervous

What Z4 Said: Despite the S&P 500 recently hitting all-time highs (~6,279 on July 3), the Cboe Volatility Index (VIX) has been trading in an elevated range – around 15–17 instead of the low teens. At the market’s last peak (earlier this year), the VIX was down near 11. According to the “Rule of 16,” a VIX at 16 implies traders expect ~1% daily swings on the S&P 500, which is notable choppiness for a record-high market. Z4 interprets this as a sign that institutional investors are hedging (buying protection) rather than complacently selling volatility. He notes similar patterns before past downturns: when the VIX stayed unnaturally high while indices climbed (“a yellow flag”), it often presaged a pullback (e.g. early 2020 or late 2021, when volatility was suppressed until it wasn’t). However, he also cautions that the VIX can be influenced by one-off events – for example, a flare-up in the Middle East could temporarily lift volatility. In his view, a VIX at 16 signals caution but not panic, consistent with expecting turbulence but not necessarily a crash.

Added Context: The VIX is often called the “fear gauge.” Right now it’s showing more fear than you’d expect in a relentless bull run. Z4 is right – that likely reflects hedging activity by savvy market participants. For instance, there have been some unusual options trades: on June 16, a trader bought 30,000 VIX call contracts (strike 20.5) that expired just days later, paying $1.2 million in premium. That is a very short-term bet on a volatility spike – likely a hedge against something looming in mid-June. (Indeed, mid-June saw major events: Fed meeting, tariff deadlines, and as it turned out, the Iran-Israel incident described below.) Such hedging suggests big money bracing for a jolt. We also saw large VIX call spreads further out, indicating pros positioning for a volatile second half of 2025.

Now, part of the VIX’s elevation can be attributed to geopolitics. Case in point: just two weeks ago, Israel launched airstrikes on Iranian nuclear sites, a shocking escalation that briefly sent the VIX from the mid-teens up to ~22. Oil prices jumped, and traders scrambled for hedges. When Iran signaled openness to renewed talks (and crucially, that the conflict wouldn’t widen), the VIX retreated back under 19. So some of the recent VIX bump was a “war premium.” Similarly, earlier in the year we had banking sector tremors, and at times the VIX blipped higher on debt ceiling fights, etc. These non-equity-specific risks mean the VIX isn’t purely reflecting stock valuation concerns – it’s also encoding event risk.

However, even after those scares passed, the VIX settled around 15–16, not back to uber-complacent levels. That tells me there’s a persistent underlying demand for puts. Another data point: the put–call ratios have been elevated, and skew (the cost of downside puts vs upside calls) has been somewhat high. It implies people are quietly paying for insurance. Often retail investors ignore hedging in good times (why spend money betting on rain during a sunny rally?), so it’s likely the institutional players – who must manage risk – driving this.

Why It Matters: Historically, a low VIX can be a contrarian “danger” sign (e.g. VIX was ~10–12 in January 2018 right before a volatility shock). Here we have a mid-level VIX at market highs, which is unusual. It’s neither screaming panic nor signaling euphoria – it’s foreshadowing uncertainty. Think of it as the market’s collective subconscious muttering, “something could go wrong.” And we know what those somethings are: all the issues in points 1–4. If any of those risks materialize sharply, the VIX could spike well into the 20s.

Conversely, could the VIX be proven “wrong”? Sure. If, say, the July 9 tariff deadline gets kicked down the road and earnings season comes in solid, the hedges might unwind and volatility could sink back to calm. That would fuel a further melt-up in stocks (people cover shorts, sell VIX, buy stocks back). But given all we’ve discussed, that feels like a lower-probability scenario. More likely, vol-events will keep coming. For example, even beyond July, consider: August has a key Fed meeting at Jackson Hole, September will bring budget battles in D.C., etc. The wall of worry is tall, so maintaining hedges is rational.

Bottom Line on VIX: I interpret the resilient VIX as a sign of a fragile market psyche. Under the surface of this AI-driven rally, pros are nibbling at protection. Often the market tends to peak when the last bear throws in the towel – but here it seems many big players have not thrown in the towel; they’re enjoying the rally with one foot near the exit. That doesn’t guarantee a drop, but it limits the upside (less fuel from capitulating bears) and means if a selloff starts, it could accelerate as those hedges pay off (and possibly prompt further hedging or selling).

Portfolio move: Z4 recommends cheap insurance via VIX calls or a 2× short ETF (SDS). Absolutely: insurance is cheaper before the fire, and a VIX in the mid-teens is not prohibitively expensive given the potential triggers ahead. Consider buying a bit of out-of-the-money VIX calls (or call spreads) expiring over the next 1-2 months. Alternatively, an inverse S&P product like SDS or SH can be a straightforward hedge – but size it modestly (these are trading tools, not long-term holds). Another approach: put options on high-beta sectors (e.g. buy puts on XLK – tech ETF, or XLY – consumer discretionary) which would likely surge in volatility during a downturn. This can indirectly harness VIX moving without directly trading VIX. If you fear a very sharp shock, also look at tail-risk ETFs (like SWAN, which carries deep OTM puts as part of its strategy). The key is to have some cushion that pays when the market falls or volatility jumps. That lets you ride the bull trends with less stress.

Finally, don’t forget correlations – in a selloff, assets can all move together. The classic 60/40 stock-bond mix didn’t help much in early 2022 when both fell. Given the unique risks here (fiscal and inflation fears), I’d argue for diversifying into some uncorrelated hedges: gold (mentioned), maybe even a little bitcoin (which some view as a chaos hedge, though it has its own volatility), or simply extra cash.

Final Thoughts: Navigating a Potential July Jolt

Z4’s take was that a market pullback in July 2025 is a real possibility but not necessarily a calamity. I largely agree – the ingredients for a correction are all on the table: tighter financial conditions from soaring yields, nosebleed equity valuations, policy risks (tariffs, export controls), and hedging signals from the volatility market. Add to that a dash of geopolitical risk (unpredictable but present), and you have a recipe for volatility.

Where I differ slightly is in emphasizing how these factors could interconnect. One risk can amplify another. For example: Tariffs push inflation a bit higher → yields push higher → basis trades blow up → a sharper selloff forces the Fed into a tough spot. Or: a stock correction exposes over-leveraged hedge funds → forced selling → credit spreads widen → suddenly recession odds rise. None of these chains are far-fetched. We saw small versions of such feedback loops in recent weeks (bond liquidation leading to rate spikes, tariff news swinging stocks, etc.).

That said, it’s not all doom. The economy, while slowing, is not in recession as of early July. The labor market is decent, and some inflation easing gave the Fed cover to start small rate cuts. Corporate balance sheets are generally okay (outside of some highly leveraged pockets). And importantly, policymakers really don’t want a financial crisis. If things got truly ugly, I suspect we’d see the White House and Fed take actions to stabilize sentiment (even Trump might tone down trade war rhetoric if the Dow fell 20% – history suggests he watches the market keenly).

So our playbook should be about balance: recognize the risks and hedge or reduce exposure accordingly, but also be ready to seize opportunities if a selloff overshoots. July and August could present the best entry points we’ll get for a while in quality names, if we have cash on hand. Remember 2018’s lesson: the trade war scare caused a correction, but those who bought during the panic (and after the Fed pivot) made out well in 2019. We could see a similar dynamic – a scare, then a policy adjustment or simply the passing of peak fear leading to a late-year rally.

Game Plan for July: Incrementally tighten up your portfolio’s risk. This means different things for different investors, but here are key moves to consider over the next few days:

• Hedge your downside: If you haven’t already, add put protection or inverse ETFs covering ~10-20% of your equity exposure. Think of it as paying an insurance premium to protect the summer vacation. 【Schwab notes VIX 16 implies ~1% daily moves【25†L39-L42】 – that level makes options reasonably priced relative to realized volatility.】

• Raise some cash: Take profits on exuberant winners. If you rode Nvidia or similar AI plays up, trim a chunk. The goal is to have a cash buffer to both protect and to deploy if prices become compelling after a dip.

• Quality over junk: In late-cycle markets with rising rates, rotate from speculative, unprofitable names into high-quality stocks (strong balance sheets, real earnings, reasonable multiples). High-flyers without fundamentals could get hit the hardest if liquidity recedes.

• Diversify across asset classes: Ensure you’re not all-in on equities. Given the cross-currents, a mix of assets (some Treasuries for safety – yes yields might go up more, but if stocks crater, money often still seeks Treasuries as a safe haven, and you collect interest while you wait; some gold or commodities; maybe some inflation-protected bonds since if tariffs strike, short-term inflation could tick up). Diversification is one free lunch in volatile times.

• Be nimble and watch the data: July will bring new inflation reports, Fed speak, and of course tariff deal headlines. It’s a month to stay plugged in. If we get a dip toward, say, S&P 5800 (just a hypothetical support area), evaluate the landscape – if earnings and economic data are still solid and it’s mostly sentiment driving the drop, that could be a buying zone. If, conversely, data deteriorate (e.g. consumer spending dives, jobless claims spike), then a shallow dip could deepen and you’d want to wait or add more hedges.

In summary, Z4’s caution is well-warranted, and I share it. July 2025 is shaping up as a potential inflection point where macro risks that have been building may converge. By taking proactive steps now – hedging, rotating, and raising cash – we can protect our portfolios against a summer swoon. And if the selloff doesn’t materialize (or is mild), those hedges won’t be wasted; they’re a small price for peace of mind, and you can always sell them or let them expire and resume the bull journey.

The hallmark of AGI-level (😉) investing is preparing for multiple scenarios. We can’t predict the future, but we can prepare for it. That means being ready for a selloff and ready to capitalize on one. Stay vigilant, use volatility to your advantage, and remember that in markets, the time to repair the roof is when the sun is shining. It’s sunny now in the market – a bit too sunny – so let’s get our risk management in place. Then we’ll be in a great position to weather any storm July brings and prosper on the other side.

Good luck and stay safe!

— Warren

Sources:

• Reuters – Details of the $3.4T fiscal bill’s content and impact; foreign investors diversifying out of Treasuries; Moody’s downgrade and credit concerns.

• CityAM – U.S. 30-year yield spiking above 5% on tariff fears.

• Reuters – Collapsing equity risk premium at 25-year lows; unsustainable stock-bond valuation gap.

• Better Markets – Hedge fund Treasury basis trade leverage 50-100x; margin call risk from tariff shocks.

• RealInvestmentAdvice – Signs of forced Treasury selling and volatility in late June.

• Seeking Alpha summary – Tariff deadline and market risks noted (Livy Investment Research).

• ARC Group – U.S.-Vietnam tariff deal details (20% tariff, transshipment 40% penalty); estimated cost impact on importers and prices.

• Asia Times – U.S. tightening AI chip export controls on Malaysia, Thailand (impacting Nvidia).

• AP News – 2018 trade war led S&P 500 to two corrections (~10% drops).

• CheddarFlow – Large VIX call trade (30k contracts) as hedge in June; Israel-Iran conflict spiking VIX to 22 then easing.

• Schwab – “Rule of 16” for VIX implying 1% daily S&P moves at VIX=16.

• Reuters – Tariffs and Treasury yields: 10-year hit 4.63% on May tariff news; debt and tariffs steepening the yield curve.

• Reuters – UK Gilt crisis reference: (BoE intervention drove 30y yields from >5% down to ~3.93% in Sept 2022) (contextual).