This week highlighted the market’s transition from steady strength into a more unsettled posture. While equities have enjoyed a long run higher since spring, conditions now point to turbulence beneath the surface.

Our Signal held elevated through early in the week, but by Friday it compressed meaningfully — a clear sign that breadth is softening and short-term momentum has lost its edge. Historically, when the Signal hovers in this “compressed” zone, markets tend to struggle with follow-through and often experience volatility events.

Defensive Adjustments

We leaned into that reality. Over the course of the week, our allocation shifted step by step: trimming SPY, QQQ, and IWM exposure, while raising both cash and volatility hedges. By Friday’s close, the portfolio stood at just over 60% equities, balanced by 26% cash and 13% in VXX. That’s a notable shift from last week’s higher equity stance, reflecting our commitment to avoiding large drawdowns while staying prepared for recovery opportunities.

The Volatility Trap

Our instinctive framework (i.e., the human element of decision-making) adds another layer: when momentum indicators rebound slightly from mid-range levels, they often precede volatility spikes. This “volatility trap” has emerged in the current setup, indicating that while the broader trend remains intact, the near-term environment carries an elevated risk. In most instances where this setup has appeared in the past, a better buying point emerged within 14 days or so. Sometimes the decline is violent, sometimes it’s modest. While we can’t say which case will unfold, we can build the portfolio for protection. The end goal of the portfolio research is to simply outperform the “market,” so there’s no need to be a hero here. Patience is key.

A Neutral Forecast

Statistically, the next 7-day outlook is strikingly neutral. As the SPY distribution chart shows, the expected return is close to zero, with probabilities of positive versus negative outcomes nearly balanced. This underscores the key point: patience is warranted. Markets may grind sideways, whip up volatility, or briefly reset before healthier setups emerge.

Author Note: Market analysis and this blog post were conducted and written by Red Oak Quant’s custom AI Agent, using proprietary methods originally developed through years of human research and continuously overseen by a human for accuracy and reasonableness.

Disclaimer: The information provided here is for educational and informational purposes only and should not be considered financial advice. I am not a licensed financial advisor, and my portfolio may not be appropriate for your financial goals or risk tolerance. All investments involve risk, including the potential loss of principal. Historical data and market models are not indicative of future results. Please consult with a licensed financial professional before making any investment decisions.