S&P 500: Alarm
First Alarm In 2025
Risk-Off Environments
So far this year, neither the DeepSeek narrative—raising questions about AI valuations—nor President Trump’s tariff moves have shaken the market into a risk-off environment. However, last week’s news of a new coronavirus outbreak in China spooked the market, triggering the first risk-off alarm of 2025. Here’s how the four key market barometers performed last week:
S&P 500 -1.66%
Nasdaq -2.26%
Russell 2000 -3.71%
Cathie Wood’s ARKK -10.18%
Understanding The Risk-Off Signal
As the first risk-off signal of the year, it’s worth revisiting how I interpret and use this indicator. My system defines the market environment as either risk-on or risk-off using three key criteria:
Short-Term Trend — Price relative to the 20-day exponential moving average on the S&P 500.
Breadth — The number of stocks making new highs vs. new lows across the NYSE and Nasdaq.
Momentum — Measured using the Percentage Price Oscillator on the S&P 500.
When all three criteria are simultaneously triggered, they consistently signal near-term market declines. My approach to this signal is straightforward: the moment it’s triggered, I shift into capital preservation mode by either reducing long exposure or hedging my long positions.
Regardless of my prior outlook (and yes, last week’s newsletter was optimistically titled “S&P 500: Lift Off, Breakout”), I always respect the risk-off signal. This is a non-negotiable rule in my portfolio management strategy.
Historical Reliability and Context
Over the past three and a half years, these criteria have triggered 13 times, with an average decline of 7.7% over a 22-day trading period.
Looking further back to the COVID era:
The risk-off criteria triggered on February 24, 2020, just before the S&P 500 dropped 32% over 20 days.
During the 2020 U.S. presidential election, the signals preceded a 6% decline in September and a 4.5% drop in the week leading up to the election.
This system has consistently proven reliable in signaling risk ahead of market declines. My primary objective with this analysis is to define the market environment, which is why every weekly newsletter begins with an overview of these three risk-off criteria. This framework is core to my own analysis and portfolio management.
The potential magnitude of the decline resides in the analysis of the near term analysis where the character of price around key moving averages aids in developing probabilities of potential decline severity, and equally establishes when the risk-off criteria become void giving probability to the return of an uptrend.
Balancing Risk & Reward
While the risk-off system is efficient at signaling downside risk, 2024 tested my conviction to my own strategy. Of the five alarms triggered, all but one resulted in moderate declines of less than 5%, with most corrections being too short to effectively position for, resulting in a series of paper cuts from hedging.
Despite this, I’ve concluded that I’m willing to accept small losses when declines are moderate and short in exchange for the ability to preserve and grow capital during more severe and prolonged downturns. I remain confident that this system will position for outperformance before the next 10-20% market decline.
The chart below of the S&P 500 visually marks the instances where all three risk-off criteria triggered an alarm.
This week’s letter marks the final edition for February, and as always with end-of-month notes, it includes updates on all active trade ideas. This week also introduces the second trade idea for 2025.
A special congratulations to readers who acted on the Alibaba and Tencent trade updates from last month—exceptional timing! An even bigger congratulations to those who considered these ideas when they were first introduced in early February 2024. Nearly a year has passed since then, and both trades have delivered remarkable results: Alibaba is up 99.6%, and Tencent is up 80%. Well done to all who seized and considered the opportunity!