Collective warning of "Bubble Wind Vane": "Trump trade" cools down, market returns to rationality.

During the trading session on Tuesday, concerns about the overheating of the US stock market dominated among investors, leading to a simultaneous drop in the three major US stock indexes. Particularly, the hottest stock under the "Trump trade" craze, Tesla, Inc. (TSLA.US), dropped more than 6%, highlighting the market's vulnerability in the face of Donald Trump's landslide election victory and the high probability of his Republican party winning both houses of Congress, leading to extreme optimism in the market. Some risky assets in the market began to show signs of a bubble. On Tuesday, many of the hottest "Trump trade" targets since last week experienced drastic upheavals ahead of the crucial CPI inflation data announcement on Wednesday. Especially, small-cap stocks, which are often more sensitive to economic conditions than large-cap stocks, plummeted significantly from historical highs. Stocks heavily shorted also saw significant drops, as did speculative tech stocks that have yet to turn a profit. The most popular risk asset, Bitcoin, experienced a sharp drop from its record high before rebounding slightly. Tesla, Inc. (TSLA.US), led by the world's richest individual, Elon Musk, saw its stock price drop from its highest point in over two years. Elon Musk, who is bullish on Trump, is likely to see his influence grow exponentially and span both the political and business realms. Tesla, Inc. is considered the strongest "Trump concept stock," with its stock price rising significantly after Trump's victory in the US presidential election, surpassing the "purest Trump concept stock" Trump Media & Technology Group (DJT.US). Even before the recent surge in the "Trump trade," the optimistic sentiment surrounding some "bubble" risk assets was already causing concerns about an "irrational boom" among investors. Given the relatively high debt burden of these risky assets, smaller stocks are particularly at risk when US bond yields rise significantly. The 10-year US Treasury yield, known as the "global anchor for asset pricing," continued to rise on Tuesday as markets feared that inflation data could dampen expectations for a December rate cut by the Federal Reserve and next year. One key index measuring speculative tech stocks that have yet to turn a profit is reaching a level not seen in recent years. Additionally, an index measuring heavily shorted stocks is nearing a trading range that suggests a possible reversal. The price movements of risk assets such as Bitcoin, Dogecoin, and Tesla, Inc. after the US presidential election indicate an alarming level of market bubble. Despite the drop on Tuesday, Tesla, Inc. has seen its market value increase by approximately $250 billion since election day, making it a prominent example of the "Trump trade" frenzy. While factors such as "fully autonomous driving without human supervision" and Robotaxi, which are fundamental to Tesla, Inc., have not undergone significant changes, investors collectively bet on Musk and his company benefiting from Trump's return to the White House. They are banking on Musk receiving the "imperial sword" to navigate the efficiency of the US federal government and drive forward the FSD and Robotaxi approval process at Tesla, Inc. For the bullish sentiment in the stock market, a significant retreat in the "bubble barometer" does not necessarily mean the end of the bull market. Market observers point out that there are signs that the US stock market may not have reached its peak yet. This month, the fear gauge of Wall Street, the Cboe Global Markets Inc. volatility index (VIX), has seen significant declines, giving traders hope that the US stock market can continue its strength. "We are entering a period in the year when stock market volatility should decrease, which is an important market signal for whether the current uptrend can be sustained until 2025," said Nicholas Colas, co-founder of DataTrek Research. Recently, Wall Street's Citigroup Inc. strategist team released a report stating that the fading "Trump trade" could temporarily steer the US stock market into a downward trajectory. Citi stated that as investors begin to take profits, the huge selling pressure from this sharp sell-off may force the US stock market to temporarily lose momentum from the epic surge after the US presidential election. The following five charts of typical "bubble barometer" provide a glimpse of the irrational exuberance in certain sectors of the market before the market's "flight to safety" on Tuesday. While signs of bullish sentiment in the market still exist, these "bubble barometers" are warning about a significant retreat in the irrational frenzy triggered by the "Trump trade." These shorted stocks experienced a pullback after a surge Before the volatility in the US stock market on Tuesday, risk appetite was evident in some speculative sectors, driving a historical surge in stocks with high short interest. Over the five trading days ending on Monday, the basket of "50 stocks with the highest short interest" compiled by Goldman Sachs Group, Inc. saw a rare increase of about 9.5%, reaching its highest level since September 2022. However, on Tuesday, this typical "bubble barometer" fell by 3.4%, and indicators such as short interest, momentum, and technical trends in these heavily shorted stocks suggest a potential significant decline in the future. The biggest beneficiaries of the "Trump trade" frenzy small-cap stocks Since the electionThose small-cap stocks in the US stock market are one of the biggest winners of the so-called "Trump trade". The bullishness of the small-cap benchmark, the Russell 2000 index, is comparable to that of Tesla, Inc. The main logic is that investors are betting on the Federal Reserve's interest rate cuts and President Trump's promises of tax cuts and "trade protectionism policies" which will greatly boost the profit expectations and overall valuations of these small-cap companies that focus on the domestic US market. This group usually tends to be more oriented towards the US domestic market than large-cap companies. However, the problem lies in Trump's other proposals, such as strict immigration laws, which may push up labor costs and squeeze the already thin profits of small businesses.Rising Out-of-the-Money Options Surging The options market is also sending out extreme bullish signals, indicating that the market's irrational bullish enthusiasm is on the rise. After the surge in out-of-the-money options, the stock market often experiences a significant pullback. Demand for options contracts betting on the rise of the S&P 500 index has been increasing significantly. On Monday, out of all the trading volume on major U.S. exchanges, there were nearly 36 million bullish options contracts, while bearish options contracts were less than 21 million. Before the decline on Tuesday, the ratio between the two was about 1.7, reaching its highest level since January 4, 2022. However, after that day, the S&P 500 index began entering a bear market period lasting almost a year. Tesla, Inc. Skyrockets to a Trillion-Dollar Market Cap The stock price of Tesla, Inc. cooled down significantly on Tuesday, but it had already approached its historical highs from the end of 2021 and the beginning of 2022 when people were rushing to buy any stocks related to electric vehicles, igniting investors' frenzy for the industry leader's stock. The global electric vehicle leader, Tesla, Inc., surpassed the trillion-dollar mark in total market value last week, and the stock price broke through the seemingly unattainable $300 level last week. Since Donald Trump was announced the winner of the U.S. presidential election, the stock has risen by over 30%. Institutional investors believe that the recent surge in Tesla, Inc. mostly stems from an emotionally driven overvaluation rather than a substantive turnaround in fundamentals, and they need to beware of the risk of valuation collapse triggered by the sustained high yield of the 10-year U.S. Treasury bond. Adam Salkhan, founder and CEO of 50 Park Investments, commented, "The market reaction triggered by Trump's victory is undoubtedly explosive for Tesla, Inc. Although Tesla, Inc. undoubtedly benefits under the Trump administration, the rapid increase in the current stock price seems too overheated in the short term. However, in the long run, the stock's prospects still look optimistic." However, analysts and market participants have different views on the attitude of the Trump administration towards electric vehicles and its potential policy impacts. Wall Street targets show that Tesla, Inc. faces a 28% downside risk, the largest valuation disparity since the fervor of tech stocks post-pandemic. ARK Innovation ETF Frenzy Other irrational buying trends also point to the irrational speculative frenzy triggered by the "Trump trades": The size of bullish options for the flagship ETF issued by Ark Asset Management, led by "Cathie Wood", ARK Innovation ETF (ARKK.US), has surged to unprecedented levels in over a year. It is worth noting that ARK Innovation ETF has significantly underperformed the S&P 500 index and the Nasdaq 100 index since 2023, positioning it at the bottom of the ETF investment return list in the U.S. market. The flagship ETF has a long-term heavy position in Tesla, Inc., which has long been the top holding of the ETF.