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One of the most important lessons I've learned over my 38 years of managing people's money for a living is Wall Street traders love their historical analogs. As such, we've developed various playbooks to track what traders typically do given various market conditions.

For the past month or so, I've been writing about the "Panic Playbook," which traders tend to use during what are called "bad news panic" market environments. Until this week, I had been fairly confident that the playbook was being implemented "To a T." We had the initial emotional decline. The oversold bounce. And the retest (well, the first retest, anyway). From there, the playbook told us that, assuming the retest was successful, a period of backing and filling - with a LOT less volatility tends to ensue.

However, the retest failed. In rather spectacular fashion. The next leg lower was launched when the White House doubled down on tariffs and appeared to be itching for a fight. As in a BIG fight - with China.

Stock Vigilantes Not Happy

Traders voted with their feet on the decision and sent stocks whooshing lower, as the S&P lost more than -14.5% on an intraday basis in just 3 days. Yikes.

Some, as in Ed Yardeni (the father of the term "bond vigilantes"), opined that the markets were sending a message to Washington. Or in this case, the "stock vigilantes" were pleading with the White House to calm things down a bit.

Back To Chapter 2

From the playbook perspective, the violent second leg down created an extreme oversold condition in the market. This meant that we needed to go back to Chapter 2: The Oversold Bounce.

And what a "big and beautiful" bounce it was after the President flip-flopped on his hardline tariff stance. Instead of never backing down, the White House decided that hitting the pause button for a few months made sense.

After all, with 77 countries lining up to negotiate, the Administration needed a little time to work through things.

Before you could identify the exact tariff level being imposed on China, the shorts were running for cover. The rally was fairly spectacular as well with the S&P surging 10.5% and the NASDAQ 100 skyrocketing 12% on Wednesday. It was the biggest gain for the S&P 500 since October of 2008. And the third best day since 1950. Spicey!

At the close of business Wednesday, the bulls suddenly had hope. You see Wednesday's big pop produced a 15-to-1 up day, which, for those keeping score at home, qualifies as a "breadth thrust" signal. So, with that in their pocket, our heroes in horns just needed some follow-through within the next day or so to be in business.

Abrupt Rally Failure?

But then another Tariff Tape Bomb landed and the fight with China didn't appear to have an easy fix. Just like that, hope turned to fear on the worry that further escalation of the trade war between the globe's two biggest economies would create real and lasting damage to global growth. Not exactly a desired result.

Something's Not Right Here

But wait, as they say, there's more. In addition to the trade war and the massive volatility occurring in the stock market, the dollar and bonds started acting strange. Instead of the traditional "safe haven" status that the greenback and US Treasuries typically provide during panicky environments, just the opposite was happening. Stocks and bonds were both going down at the same time.

Even when we got great news on inflation this week (both CPI and PPI surprised to the downside) bond yields went up. Big time. Wait, what?

There are several theories in play here. The obvious macro argument is bond yields are rising because of inflation expectations. In case you've forgotten, just about everyone on the planet - save those employed at 1600 Pennsylvania Avenue - see tariffs as a tax that will inevitably increase costs.

Then there is the latest "unwind" in hedgie-land. Yes fans, another favorite trading technique among the masters of the financial universe is getting hit. Apparently the "basis point" and "swap spread" trades are blowing up and creating forced selling of bonds.

The result has been the biggest move in yields since the COVID crash. For example, the yield on the US 10-Year Treasury Note moved from 3.89% to an intraday high on Friday to 4.6% - in just 6 trading days. This is a huge move up, especially when bond yields usually fall during times of turmoil.

Then There Is China

The final theory behind the abnormal behavior in bonds has China either "dumping" or simply not buying US Bonds as a form of trade war escalation. (You mess with us, we mess with you!)

While there is no hard evidence to be had (because China doesn't provide details on their plans) one analyst wrote, "China may be selling Treasuries in retaliation." Bloomberg reports that in a note to clients, Ataru Okumura, a senior interest-rate strategist at SMBC Nikko Securities in Tokyo wrote, China has an incentive to show "it won't hesitate to cause turmoil in the global financial market in order to improve its negotiating power against the US." Super.

Will Things Start to "Break?"

The point to all of this is that I believe we need to switch playbooks here. In short, we need a game plan that includes the possibility of "things breaking". We've learned that when crowded trades blow up, there is forced selling - usually lots of it. This causes unintended consequences such as securities going haywire. Examples include the "Volmageddon" and COVID crashes, where all kinds of financial vehicles "broke" for a period of time.

To be clear, I am NOT suggesting ETFs or other securities will start to malfunction. I'm not even sure that the volatility will continue for much longer. However, given the rather strange behavior going on in traditional safe havens, I want to be prepared. Just in case.

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