We are at an inflection point in the market, as we have been on multiple occasions. The S&P 500 is being led higher by fewer and fewer names. Market positions are becoming more and more concentrated in these names as they gain value. It is literally a monster that is eating itself.
Think about it this way, there are about a bajillion indexes that try to track the S&P 500, SPY being the biggest. Some are index funds, that try to simply blindly follow the index. Some are a little more creative and have some leeway (these are an ancient form of index fund called a ‘mutual fund’).
While the index funds simply holding the basket of the S&P 500 will do a good job of creating the index… How do inflows affect index funds? Where do those dollars go? If the index fund is tracking the S&P it is spending about 20% of its dollars on 5 stocks. Like it or not that is going to create demand. This is going to drive the cost of the ‘Big 5” (shout out to Philly B Ball), the natural demand of index funds pushes more assets into the Big 5 (or FMAGA).
This also causes hedge funds and asset managers to need to chase, as more and more of an index’s holdings are driven by fewer and fewer stocks. Diversification actually looks WORSE not better to the client, who will say that they want safety but complain of underperformance. This creates a pocket of demand.
Finally the retail trader, who knows little about the stock market (for the most part) sees the Big 5 everywhere; they dominate the news and they buy these names. Retail traders create another small, but real pocket of demand that runs FMAGA stocks higher.
Thus, if you look at today’s market you might see flat, but in reality what you are actually seeing is 5 stocks go up, and about 3-4 hundred stocks go down. For real insight I like to look at the sector spdr indexes to see what they are doing, not just the main 4 indexes.
If we now hone in on realized volatility, there is a really good reason we are seeing realized volatility take a real drop. We have a strange Tug-Of-War.
What we have are 5 NFL football players on one side, on the other an entire Jr. Varsity football team. Right now, the 5 are stronger. However, if one or two of the NFL players let go, the JV team is going to start pulling the rope MUCH harder.
While there are 5 NFL players though, it basically stops the rope from moving (or it creeps in their direction). Thus as long as FMAGA is strong, expect realized volatility to continue its downtrend.
You can clearly see the downtrend in 10 and 20 day HV
As you can see 20 and 10 day HV are on a CLEAR downtrend. Realized vol is now below 30. Not because most of the market isn’t moving, but because of pulling in two directions.
While movement is decreasing it is going to be hard for the VIX to stay afloat. That said, smart people see the risk that is out there (listen to Buffett over the weekend, he was not buying ANY stocks).
This is why the VIX is still above 30 and we are still backward (mostly).
I do think it is interesting that the cash is below the future again, but backwardation remains. In fact, the Jun future really has not moved much at all. Looking at the curve above, I see a classic yellow light. We could see VIX pop right back, or we could see it drop. What will be difficult though is for Vol hedging to work exceptionally well with straight calls.
I continue to be a proponent of complex spread in the VIX itself and short dated trend following trades in the ETFs. VXX might finally start to look like an interesting short if the May future drops some, but until then I think sticking to VIX itself, or LONG dated VXX or UVXY makes the most sense.
Finally, I want to take a quick look at VVIX.
While the index has had a nice drop from the highs, it has stabilized and may in fact be trending higher. This is not a bullish sign for the market but is bullish for the VIX.
Traffic Lights
SPX: YELLOW
SPX IV: YELLOW
VIX: YELLOW
VIX IV: YELLOW
VXX: YELLOW
Your Only Option,
Mark