A Small Bull-and-Bear Fight Before Santa Arrives ?

This week, we have seen a streak of red candles forming under relatively low volatility. Today, after opening in the green, the session turned into the worst day of the series. This naturally raises the question: are we heading back into a full-blown correction, or will Santa soon make us forget these few bad days?

The concern is amplified by the fact that, as I am writing these lines, we are less than an hour away from the U.S. president addressing the nation. Rumors suggest he will highlight the administration’s economic achievements over the past year and outline priorities for 2026, with the goal of reversing bearish sentiment about the economy. Given how the last address to the nation on Liberation Day last April played out for the market, it is only natural to feel a bit uneasy.

In this post, we will go through what most of our signals are currently indicating, with a focus on what I believe is the most probable direction for the market.

Bearish price action under low volatility

Last Thursday, the market found enough bullishness in Jerome Powell’s comments for the S&P 500 to close at a new all-time high.

Making new highs is generally bullish from a longer-term perspective, but it says little about near-term direction. Since then, we have only seen the market retrace. Despite a series of four consecutive red candles, the damage on the S&P 500 has been very moderate (2.5%), largely thanks to a low-volatility environment. Indeed, as we can see below, although the VIX ribbons have narrowed, the move itself has remained very limited, even today, despite the larger index decline.

From this chart, the VIX ribbon still appears very far from inversion.

This is broadly what we expected, as our WU Advanced Volatility Trend indicator — which on average does not flip frequently — has recently moved back into a low-volatility environment.

Being in a low-volatility environment does not mean the market will only experience bullish price action. Rather, it implies that the amplitude of moves should remain limited. For example, in 2023, in the middle of a low-volatility regime, the market went through a three-month pullback characterized by relatively moderate candles, yet the total retracement was only about 10%.

This stands in sharp contrast to pullbacks that occur during high-volatility environments, such as the tariff-related selloff, which saw a 21% decline in roughly half the time, or the COVID crash, which inflicted roughly twice the damage we experienced in April over a similar duration.

These are extreme examples, but the point remains: unless we see a sudden shift in the volatility regime, price action should continue to remain relatively moderate — which is exactly what we have seen so far.

Rotation ?

The damage has been more pronounced on the Nasdaq 100, which was already underperforming SPY on a beta-adjusted basis. Not only did it fail to make a new high last week while SPY did, but since then it has also declined more than what we would normally expect given its beta (QQQ beta ≈ 1.22).

We were already aware that QQQ had been underperforming SPY since mid-November. Last week, it was on the verge of flipping back to a bullish relative trend, which explains why we chose exposure through a QQQ-related ETF rather than a SPY-related one. That said, the Fed press conference reversed this emerging trend and extended the Q’s underperformance.

This lack of strength in tech is much more indicative of a rotation than of a full-blown panic-driven correction.

Our market breadth indicator also points toward rotation rather than the beginning of a broad market correction. Indeed, the signal has only risen very moderately over these four consecutive red daily candles, which is not what we would typically observe during a 4.2% pullback in QQQ.

When a full market correction begins, small and riskier companies are usually hit first, which causes this indicator to spike sharply—sometimes even before significant damage appears in the major indices.

Will Santa reverse the trend?

This bearish price action has caused one of the components of our Risk Index to flip. Specifically, our NYSE and Nasdaq derivatives volume signal — which was already in a non-euphoric state — has just turned bearish for the first time since the tariff feud last April.

As a result, our Risk Index is now at a value of 1, with our options model sitting right at its threshold, which could potentially push the index up to 3.

This is consistent with the fact that the market has not been easy over the past few weeks and was not starting from an euphoric bullish position.

It is also worth noting that our implied correlation remains well below its threshold. This suggests that, even in the options market, the damage is more concentrated at the index level than within its individual components — once again pointing toward rotation rather than the beginning of a full-blown panic move.

Markets rarely move in a straight line, and after four consecutive days of bearish price action, we should be approaching at least some green candles. It is still too early to say whether this would merely be a relief bounce or the start of a trend reversal. Two upcoming catalysts could help decide.

Tomorrow morning brings the first inflation report since the U.S. government shutdown. A very poor reading could seal the market’s fate. Friday will also be a quadruple witching day, one of the four dates each year when multiple derivatives contracts expire simultaneously. On these days, stock options, index options, index futures, and single-stock futures all expire at the same time. This concentration of expirations often leads to elevated trading volume and, at times, increased short-term volatility as positions are rolled, closed, or rebalanced.

But several readings suggest that if tomorrow’s inflation report comes in favorably and the president’s speech is perceived positively, the market could enjoy a constructive period around Christmas. Indeed, the QQQ RSI is already at a relatively low level from a long-term statistical perspective. While it is not at an outlier extreme, it currently sits in the 9th bin below the median RSI value when looking at a 30-year history divided into 16 bins (below the median). Considering how moderate the recent retracement has been, this positioning is non-negligible and supports the case for a short-term rebound.

We also observed a sharp impulse higher in downside protection in the options market, reaching levels last seen in April. The last time we reached those levels, there were only two days left in the correction.

When everyone simultaneously seeks protection, the market’s path of maximum pain often flips bullish.

At the same time, we have started to see a meaningful cooldown in SKEW. So far, the move amounts to about 9 points. Historically, since 2018, pullbacks have seen an average SKEW cooldown of roughly 16 points. In that context, a significant portion of the adjustment may already be behind us—especially given how limited the downside move in SPY has been so far.

At first glance, it may seem contradictory that our option impulse surged—indicating a broad rush into bearish protection—while SKEW declined. In reality, these two indicators measure slightly different dynamics. Our option impulse (like our NYSE and Nasdaq derivatives volume) captures activity across all types of options. SKEW, on the other hand, focuses exclusively on deep out-of-the-money downside protection, typically dominated by puts that are roughly 10% to 30% out of the money—options that are unlikely to ever pay out, but that can deliver significant gains if conditions deteriorate sharply.

This suggests that while investors have aggressively added short-term protection, the pricing of extreme tail risk has already started to ease.

Conclusion

So, in summary, the low-volatility environment we are currently experiencing is not particularly concerning, and we do not mind too much the recent sequence of bearish candles. As explained above, unless we get a very poor inflation report tomorrow, we believe next week should be more constructive than this one, allowing for a more relaxed end-of-year period heading into Christmas.

Additionally, the current QQQ trade driven by our hedge signal is now trading below the closing level of every other comparable trade over the past 20 years.

One point we made last summer, when we exited our leveraged QQQ and UPRO positions, was that the trade had advanced too far relative to historical statistics for the amount of time invested. Combined with the fact that our margin signal was at 15, this led us to believe we were simply too far ahead on a trade that was likely to retrace. While that hedge signal trade ultimately ended up being one of the strongest in the algorithm’s history, it still experienced a few percent pullback from that point like we predicted.

Applying the same reasoning today suggests that we should not be too far from seeing some green candles. Although the strategy’s maximum temporary drawdown on QQQ is around 9.5%, no trade has ever closed at levels as low as where we currently stand. Moreover, the three historical instances that reached drawdowns close to this 9.5% level ultimately turned into strongly positive trades. While this is not a large enough sample to draw firm conclusions, it does suggest that better price action could be ahead.

On a longer-term basis, however, I am slightly more bearish than I was this summer. Employment data has not come in particularly strong, which aligns with other economic signals we are observing, such as persistently weak PMI readings and mixed guidance in recent earnings reports. The market could still rally in the short term if incoming data remains “not too bad.” Nothing is broken yet, and the three consecutive rate cuts by the Fed, combined with the resumption of roughly $40 billion in short-term Treasury purchases, could continue to fuel the extraordinary bull market that began with the AI-driven surge following ChatGPT’s launch in late 2022.

That said, this is a point where the economic narrative needs to improve. Now that we are an hour past the president’s speech, it has become clearer that part of its objective was precisely to restore optimism and encourage a reversal in economic momentum.

The coming months will be critical, and a careful investor should once again keep an eye on the Sahm Rule, which has declined meaningfully this week.

Many of us have been watching this indicator for over a year, including during its first false trigger at the threshold. While that episode weakened confidence in the signal, the Sahm Rule remains a powerful indicator. The threshold chosen by Claudia Sahm did not statistically favor avoiding false positives, but it would be surprising to see two consecutive false signals given the historical record. Moreover, our own adjusted threshold—defined prior to the false trigger—held up well during that episode. Hopefully, it will not be tested in 2026, as that would definitely be a very bearish signal.

Varia

We have been amazed by how much PAND·AI has been used so far. We did encounter a few bugs following the launch, but nothing major. Thanks to your help, we have already fixed most of them. We are now close to releasing a key feature that was planned from the beginning but missing at launch: a summary of market sentiment drawn from social media and major financial news websites for a given stock.

Rolling out this feature came with meaningful computational and cost constraints, as it relies on advanced agentic AI workflows rather than simple LLM API calls. That said, we are hopeful to make it live this Friday.

In the associated post, I’ll share some statistics we’ve collected on PAND·AI. After all, it’s your data.