"Bubble Barometer" Collective Warning: "Trump Trade" Cools Down, Market Returns to Rationality

According to the Zhitong Finance APP, during Tuesday's trading hours in the U.S. stock market, investor concerns about the overheating of the U.S. stock market dominated, leading to declines across the three major U.S. indices. Notably, Tesla (TSLA.US), the hottest stock under the "Trump trade" wave, plummeted over 6%. This highlights that following the overwhelming election victory of President Donald Trump and the high likelihood of his Republican Party winning both the House and Senate, there has been extreme optimism in the market, resulting in a bubble feeling for some risk assets. Additionally, some of the riskiest stocks, also known as "bubble barometers," experienced a sharp drop after a short-term surge, indicating the fragility of the "Trump trade" and the gradual fading of this trading wave.

On Tuesday, many of the hottest "Trump trade" targets since last week experienced significant volatility ahead of the crucial U.S. CPI inflation data to be released on Wednesday. In particular, small-cap stocks, which are often more sensitive to economic conditions than large-cap stocks, fell sharply from near historical highs. Stocks with concentrated bearish bets also saw significant declines, as did speculative tech stocks that have yet to turn a profit.

The trading price of Bitcoin, one of the hottest risk assets, fell sharply from its record high before recovering slightly. Tesla (TSLA.US), led by the world's richest man Elon Musk, who is determined to "go all in" on Trump, saw its stock price drop from a two-year high.

Musk's influence, betting on "King Trump," is likely to grow exponentially and span both political and business circles. Tesla is considered the strongest "Trump concept stock," with its stock price surge far exceeding that of the "purest Trump concept stock"—Trump Media & Technology Group (DJT.US)—after Trump announced his victory in the U.S. presidential election.

Even before the recent wave of "Trump trades" triggered a super surge, the optimism surrounding some "bubble" risk assets began to raise concerns among investors about "irrational exuberance."

Given the relatively high debt burden of these risky assets, smaller stocks are particularly at risk when U.S. Treasury yields rise significantly. On Tuesday, the 10-year U.S. Treasury yield, known as the "anchor of global asset pricing," continued to rise as the market worried that inflation data might dampen bets on the Federal Reserve's rate cuts in December and next year.

Notably, a benchmark index measuring unprofitable speculative tech stocks is approaching a level that has been difficult to surpass in recent years. Additionally, an indicator measuring heavily shorted stocks is nearing a trading range that suggests a potential reversal.

"Assets like Bitcoin, Dogecoin, and Tesla show an astonishing level of market bubble following the U.S. presidential election," said Mike O’Rourke, chief market strategist at Jonestrading. "The market behaves as if every trade is happening in a vacuum, but that’s not how the market operates. They are interconnected."

Even after Tuesday's decline, Tesla's gains since election day have added approximately $250 billion to the market value of this electric vehicle manufacturing giant. This makes it one of the most prominent examples of the "Trump trade" frenzy following the U.S. presidential election, although there have been no substantial changes to the core factors related to Tesla's fundamentals, such as "fully autonomous driving without human supervision" and Robotaxi However, after Trump's victory, investors collectively bet that his return to the White House would benefit the electric vehicle company led by Musk, gambling that Musk would gain the "imperial sword" to navigate the efficiency of the U.S. federal government, thereby promoting the approval process for Tesla's FSD and Robotaxi.

For the bullish sentiment in the stock market, a significant pullback in the "bubble barometer" does not mean the end of the bull market. Market observers point out that there are signs indicating that the U.S. stock market bull run may not be over. This month, the fear gauge on Wall Street—the Chicago Board Options Exchange Volatility Index (VIX)—has significantly retreated, giving traders hope that the U.S. stock market can maintain its strength.

"We are entering a period of the year when stock market volatility should decrease, and this decline in volatility is an important market signal for whether the current rally can be sustained into 2025," said Nicholas Colas, co-founder of DataTrek Research.

The strategist team at Citigroup Inc recently released a report stating that the retreat of the "Trump trade" could lead the U.S. stock market to temporarily enter a downward trajectory. Citigroup noted that as investors begin to take profits, the massive selling pressure from this sharp sell-off could force the U.S. stock market to temporarily lose momentum after the epic rally following the presidential election.

The following five typical "bubble barometer" charts show the irrational excitement in certain sectors of the stock market before Tuesday's market "risk-off action." Although signs of bullish sentiment remain, these "bubble barometers" have already warned of a significant retreat in the irrational enthusiasm triggered by the "Trump trade."

These stocks targeted by short sellers have experienced a pullback after a surge.

Before the fluctuations in the U.S. stock market on Tuesday, risk appetite was clearly reflected in some speculative sectors of the U.S. stock market, driving some stocks with high short ratios to experience historic surges. Over the five trading days leading up to Monday, the "basket of 50 stocks with the highest short ratios" compiled by Goldman Sachs rarely rose about 9.5%, reaching its highest level since September 2022.

However, on Tuesday, this typical "bubble barometer" fell by 3.4%, and the short ratios, momentum, and technical trends of the stocks with the largest short-selling forces indicate that a significant decline may occur in the future.

The biggest beneficiaries of the "Trump trade" wave—small-cap stocks.

Since the election, those small-cap stocks in the U.S. market have been among the biggest winners of the so-called "Trump trade." The bullish sentiment for the small-cap benchmark—the Russell 2000 index—is comparable to that of Tesla, primarily based on the logic that investors are betting on a rate-cutting cycle by the Federal Reserve, as well as the elected President Trump's promises of tax cuts and "trade protectionist policies" that will significantly boost the profit expectations and overall valuations of these small-cap companies focused on the domestic U.S. market, which typically lean more towards the domestic market than large-cap companies But the problem is that other proposals from Trump, such as strict immigration laws, may drive up labor costs and squeeze the already thin profits of small businesses.

Surge in "Irrational" Call Options

The options market has also sent extremely bullish irrational signals, indicating that the market's irrational bullish enthusiasm is heating up. After this "irrational" surge in call options, the stock market often faces a significant correction.

Demand for options contracts betting on the rise of the S&P 500 index has been significantly increasing. On Monday, nearly 36 million call options contracts were traded across major U.S. exchanges, while put options contracts were less than 21 million. Before a decline on Tuesday, the ratio of the two was about 1.7, reaching the highest level since January 4, 2022. However, after that day, the S&P 500 index began to enter a bear market period lasting nearly a year.

Tesla Soars to a Market Value of Over $1 Trillion

Tesla's stock price saw a significant cooling on Tuesday, but the stock is close to the historical highs of late 2021 and early 2022, when there was a rush to buy any stocks related to electric vehicles, sparking investor frenzy for the industry leader's shares. Tesla, the global leader in electric vehicles, saw its total market value surpass the $1 trillion mark last week, with its stock price breaking the long-elusive $300 barrier. Since Trump announced his victory in the U.S. presidential election, the stock has risen over 30%.

Institutional investors have indicated that Tesla's recent surge is primarily driven by high valuations based on sentiment rather than substantial fundamental reversals, and there is a need to guard against the risk of valuation collapse triggered by persistently high 10-year U.S. Treasury yields.

Adam Sarhan, founder and CEO of 50 Park Investments, commented: "The market reaction triggered by Trump's victory is undoubtedly explosive for Tesla. Although Tesla can certainly gain some potential benefits under Trump's administration, the rapid rise in the current stock price seems overly enthusiastic in the short term. However, in the long run, the stock's development prospects remain optimistic."

However, analysts and market participants hold differing views on the Trump administration's attitude toward electric vehicles and its potential policy impacts. Wall Street target prices indicate that Tesla's stock price faces a 28% downside risk, the largest valuation divergence since the post-pandemic tech stock frenzy

ARK Innovation ETF Frenzy

Other irrational buying trends also point to the irrational speculative frenzy triggered by the "Trump trade": The scale of call options for the ARK Innovation ETF (ARKK.US), the flagship ETF issued by Ark Investment Management led by "Cathie Wood," has rarely surged to extreme levels not seen in over a year. It is worth noting that the ARK Innovation ETF has significantly underperformed the S&P 500 Index and the Nasdaq 100 Index since 2023, consistently ranking at the bottom of the investment return list among similar ETFs in the U.S. stock market. This flagship ETF has long held a significant position in Tesla, which has been its top holding for an extended period.