Trade War Resurfaces: Market Jitters, AI Bubble, & Auto Loan Stress

The financial markets have recently presented a compelling dichotomy: a robust rally, marking the strongest post-15% sell-off surge since 2001, has prompted both enthusiastic market chasing and considerable investor apprehension. Following an impressive ascent off the "liberation week" lows, many clients and advisors have expressed unease about the sustainability of this upward trajectory. Our internal outlook had suggested a potentially favorable calendar for the stock market, particularly in the first year of a Presidential cycle, provided no significant disruptions emerged by late October. However, this optimistic forecast was challenged by a sudden resurgence of trade tensions.

Trade War Escalation Reignites Market Concerns

A period of relative calm on the trade war front, which had largely contributed to the market's summer and fall rally, concluded abruptly. China initiated expanded export controls on crucial rare earth materials and related processing technologies, encompassing five new elements and tightening restrictions on existing ones. Notably, these controls specifically prohibit exports for military applications. This move was a direct response to recent export limitations imposed by President Trump on American chip sales to China.

In a swift retaliation, the President announced an additional 100% tariff on all imports from China, effective November 1st, coinciding with China's export controls. These new tariffs represent a substantial increase from the current average of 30%. Furthermore, expanded export controls were implemented on "any and all critical software." While the President suggested this could be a negotiation tactic, emphasizing that "the timeline could move up depending on how China reacts," the immediate stock market reaction reflected significant concern. Investors are now watching to see if the "TACO" trade (Trump Always Chickens Out) – where the President often softens his threats in response to severe market declines – will come into play.

Market Charts: Assessing the Damage and Perspective

Friday's announcements triggered a nearly 3% loss in the stock market, evaporating approximately one month of gains on short-term charts. Despite this, a broader perspective reveals that the S&P 500 remains up 59% since the Federal Reserve concluded its rate hiking cycle in November 2023, underscoring the magnitude of the preceding rally.

From a technical standpoint, the S&P did incur some damage. The Relative Strength Index (RSI), a momentum indicator, had previously shown "non-confirmation" by failing to confirm new market highs, and on Friday, it broke to a new rally low. While the 50-day moving average held, the rapid "melt-up" since July resulted in a lack of strong traditional support levels. Round numbers such as 6500 and 6400 might now act as psychological entry points for investors who feel they missed the earlier rally.

Our intermediate-term trend following systems, designed to identify broader market movements, indicate that despite the recent dip, the market would require a more substantial correction to trigger a sell signal. These systems utilize "bands" around moving averages to define trends. The S&P 500 has consistently traded above its upper band, signaling a momentum-driven market prone to volatility, which can be exhilarating during ascents but challenging during downturns if investors are unprepared.

Fixed Income and Digital Assets Overview

In the bond market, Treasury yields experienced a slight dip but largely maintained levels reminiscent of those preceding the 2007/2008 financial crisis. The yield curve, particularly from 6 months to 20 years, continued to exhibit a "normal" shape, with a general shift downwards last week. The lower 6-month yields suggest that the market anticipates further rate cuts from the Federal Reserve.

Crucially, corporate bonds did not exhibit panic on Friday. Spreads remain just above their all-time lows seen in 2006 and 1999. A closer examination of a one-year chart reveals only a minor move off these lows, indicating some underlying concern but no immediate evidence that Friday's trade war news is perceived as a fundamental game-changer for credit markets.

Conversely, digital assets, including Ethereum and Bitcoin, experienced significant declines on Friday, although their direct correlation to renewed US-China trade tensions is not immediately clear. Interestingly, despite the sharp price drop, only Ethereum showed a net decrease over the past month, with other digital assets holding relatively steady.

The AI Market: A "Recycling" Conundrum?

Amidst the enthusiasm surrounding artificial intelligence, growing concerns are emerging about the structure of the AI-driven market, drawing parallels to the dot-com bubble of the late 1990s. While acknowledging AI's transformative potential, the current investment landscape exhibits characteristics reminiscent of past speculative booms, particularly the phenomenon of companies buying and selling from each other, or "recycling" revenue.

This recycling dynamic, where companies like Nvidia are even investing in their own customers, raises questions about the true economic substance behind soaring valuations. Lease and rental agreements tied to investments and future contract promises evoke memories of the accounting intricacies and market exuberance that preceded the tech bust. While the underlying technology is indeed a game-changer, the timeline for realizing substantial, widespread business profits remains highly uncertain. The current historic valuation levels therefore pose considerable risks, suggesting that not all participants will generate returns.

Oracle's Margins: A Canary in the Coal Mine?

A recent disclosure from Oracle served as a stark reminder of these "recycling" risks. The company quietly reported a $100 million operating loss associated with its aggressive push into AI cloud infrastructure, specifically from leasing Nvidia's Blackwell chips. This segment, widely anticipated to be a profit engine for Oracle, instead revealed razor-thin gross margins of 14% on $900 million in revenue from Nvidia-powered rentals. This contrasts sharply with the 70% margins typical of Oracle's traditional software business, placing its AI cloud margins closer to those of a retail giant like Costco (13%).

This significant loss comes after Oracle's massive $40 billion commitment to Nvidia chips for OpenAI's Stargate data center, deepening its reliance on Nvidia's pricing and supply chain. A key concern arises from Nvidia retaining ownership of these rented chips, booking the rental income as profit. If a major customer like Oracle struggles to generate sufficient profit from these chips, it raises questions about the long-term valuation of Nvidia's assets and the sustainability of future rental revenues. While not an immediate crisis, this situation could, in hindsight, be seen as an early indicator of underlying market vulnerabilities.

Comparing Oracle's operating margins (dark orange line) to other leading AI-related companies reveals its competitive disadvantage. Nvidia's exceptionally high margins, juxtaposed with Oracle's struggles to profit from its chip investments, prompt further inquiry into how many other Nvidia customers face similar challenges, and whether such high margins are sustainable in the long run.

Investing in Customers: A Double-Edged Sword?

The practice of chip manufacturers investing in their customers further complicates the AI investment landscape, reminiscent of speculative practices from the late 1990s. OpenAI, a prominent private AI entity, has secured deals with both Nvidia and AMD. Nvidia, instead of receiving cash for chip leases, has been granted an equity stake in OpenAI. The valuation of this private equity stake and the accounting treatment of these leases introduce considerable subjectivity and potential for ambiguity.

Similarly, AMD has sold chips to OpenAI, offering warrants to purchase AMD stock as an incentive. The market reacted positively to this news, driving AMD's stock higher. This dynamic implies that OpenAI could potentially use profits from these warrants to finance future chip purchases from AMD, creating a somewhat circular economic model. While exciting for stock performance in the short term, the long-term viability hinges on OpenAI's eventual ability to generate substantial profits from these chips through end-user demand. Historical precedents suggest that such deals often become increasingly elaborate to sustain momentum, with the ultimate hope that actual businesses and consumers will eventually drive real revenue.

Another Warning Sign: Sub-Prime Auto Loan Delinquencies

Beyond the tech sector, another potential economic warning sign has emerged from the sub-prime auto loan market. Recent reports indicate that the default rate on these loans, typically extended to borrowers with credit scores below 620, has reached its highest level since 1994. These loans are often utilized by young adults or lower-income households.

The escalating delinquency is a multifaceted issue, driven by a combination of persistently high vehicle prices, elevated interest rates, and broader inflationary pressures that have strained household budgets. Many borrowers who secured loans during the period of pandemic-era stimulus are now confronting monthly payments that exceed their capacity. This trend is causing apprehension among lenders and investors in asset-backed securities tied to auto loans, with some lenders already tightening credit standards or withdrawing from the subprime market. Continued increases in delinquencies could trigger broader economic ripples. This situation starkly illustrates the "K-shaped" economic recovery, where higher-income segments continue to prosper while the lower half of the economy faces increasing challenges. Historically, such divergence eventually creates broader economic issues, and a downturn in the auto market could be an early manifestation.

SEM Market Positioning Amidst Volatility

SEM employs three distinct investment approaches: Tactical, Dynamic, and Strategic, which correspond to daily, monthly, and quarterly adjustments, respectively. Currently, the Tactical system, focused on high-yield investments, has maintained its position since April 23, 2025, following a brief exit earlier that month, though high-yield spreads are being closely monitored for slowing trends.

The Dynamic system shifted to a "bearish" stance in June 2025, having been "neutral" for the preceding eleven months. This defensive posture involves liquidating risky assets, specifically 20% dividend stocks in Dynamic Income and 20% small-cap stocks in Dynamic Aggressive Growth. Concurrently, the interest rate model remains "bullish," favoring higher-duration (Treasury Bond) investments for the majority of bond allocations.

The Strategic system, with its core rotation adjusted quarterly, saw one trend model sell on April 4, 2025, and re-enter on June 30, 2025. Recent adjustments on August 17 included a rotation from mid-cap growth into small-cap value, alongside selling some large-cap value to purchase broad large-cap blend and growth funds. These large-cap investments are in actively managed funds designed for greater diversification beyond the market's top performers. On January 8, a complete rotation out of small-cap value and mid-cap growth occurred, favoring another diversified large-cap blend fund and a Dividend Growth fund. While trend models are monitored daily, their trading is infrequent, aiming to avoid major downturns, even if it means selling prematurely in a rapidly rising market.