Time for Some Armageddon Trades
After the big rally, equities are overbought, China is slowing and Europe and Japan look weak. So you best get ready for when the fun stops.
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Both the S&P 500 and Nasdaq surged more-than 3% last week to hit all-time highs. Volatility continues to drop with the S&P VIX Index (VIX) ending Friday at just over 16, compared to just over 50 following the announcement of reciprocal tariffs early in April. It has been a remarkable rally off stock market lows in April. Investors have caught some breaks as tariffs have not bled into inflation readings as of yet. In addition, the regional war potential between Israel and Iran was over almost as quickly as it began. It also looks like the federal budget for fiscal 2026 could be passed soon with a significant rise to the debt ceiling, which would take more uncertainty off the table.
All that said, the amount of investor complacency around these markets is quite astounding. By many valuation metrics, such as price-to-sales and market-cap-to-GDP ratios, equities are significantly more overbought than at the tail end of the Internet Boom. As importantly, the economic backdrop isn’t nearly as supportive as it was at the end of the 1990s. Boomers were in their prime earning years then. Now more than 10,000 a day are hitting retirement. The U.S. enjoyed four-straight years of 4%-plus gross domestic product growth from 1996 through 1999. Now, the U.S. will be fortunate to grow 2% in 2025 after a 0.5% contraction in the first quarter.
The federal debt situation is a mirror image of what it was during the Internet Boom. The federal government had a small budget surplus in 1999. The federal debt entered the 21st century at just less than $6 trillion -- meaning the federal government has added as much to the debt in the last three years than the country did from 1776 to 1999. Our near $2 trillion annual fiscal deficits haves contributed heavily to the tepid economic growth the country has experienced in recent years but is obviously unsustainable.
Nor should investors count on economic growth from the second largest economy in the world, China. The Middle Kingdom has a much worse government debt challenge than the U.S. if one includes regional governmental debt. Real estate continues to be a massive overhang to growth and there even have been some recent rumors about a potential regime change. The trade dispute with the U.S. is just another negative for the country. Japan is projected to deliver just 1% GDP growth in 2025. European GDP growth this year is tracking to more tepid growth than that. In summary, I have a hard time seeing what is going to drive the economic growth the market seems to be pricing in during this rally.
I did some Armageddon trades last week for the first time in 2025. There are long dated, significantly out of money bear put spreads around the SPDR S&P 500 exchange-traded fund SPY. These will pay 10 to 15-to-one if the S&P 500 falls 20% to 25% over the next year. I keep approximately 1% of my overall portfolio allocation in these types of trades over a rolling 12-month period when I believe the market is significantly overvalued, like I do now. I cashed in a few of these trades in the first part of April when stocks had their sharp drop.
Approximately a quarter of my portfolio remains within short-term treasuries. Almost all the rest of my holdings are within covered-call positions around the few stocks sporting reasonable values in this market. In this way, I can continue to participate in the rally if it continues. However, I am also well prepared should equities lose their ability to dodge bullets at some point in the months ahead.
At the time of publication, Jensen was short SPY via long dated out of the money bear put spreads.
