Shares of the largest US companies are moving wildly out of sync, creating a sense of calm in the S&P 500 Index not seen in years. But it’s a different story when it comes to the rest of the market.
While a Cboe gauge of implied correlation for the 50 largest S&P 500 stocks has recently hit a record low, the equity index’s equal-weighted counterpart is close to the 64th percentile relative to the past year, according to an analysis from Susquehanna International Group. That dynamic signals that even though the big names are trading more independently, investors see the others moving much more in tandem.
The concern now is that a spike in volatility is inevitable should correlations align across the market — and few are prepared for it.
Part of the discrepancy can be chalked up to outsized leaps from Wall Street’s artificial intelligence all-stars, compared with fairly meager moves from practically everything else. Nvidia Corp.’s 149% surge that took its market value above $3 trillion has represented nearly a third of the S&P 500’s gain this year, while almost 40% of the index’s stocks are actually down.
“The market has been broken up into two groups: 1. Nvidia and Magnificent 7; and 2. The other 493. The correlation between those two groups has been low, which has pressured S&P 500 correlation,” said Chris Murphy, co-head of derivatives strategy at Susquehanna. “When looking at S&P stocks on an equal-weighted basis, the outsized impact of the MAG7 as a group and NVDA specifically is neutralized.”
The low Cboe 3-Month Implied Correlation Index has helped depress the VIX index, which averaged its lowest reading since 2017 in the first half of the year as the S&P 500 jumped 14%. At the same time, the return from being short a one-month VIX futures contract reached its highest level since “Volmageddon” in early 2018. Back then, a period of market calm was shattered and funds that had piled into volatility-selling strategies were forced to the exits, sending the VIX spiking.
For now, calm still pervades the market, and a JPMorgan Chase & Co. survey in June showed almost 75% of respondents expect the VIX to average between 13 and 17 for the rest of the year. Less than 1% of respondents see it averaging more than 20.
But with a contentious presidential election looming and varying expectations for Federal Reserve interest-rate cuts, things could change.
One volatility watcher is keeping an eye out for signs of stress. According to Kris Sidial, co-chief investment officer at Ambrus Group LLC, an uptick in tail-risk hedging on the S&P 500 could indicate “margin stress,” while a shift in the VIX futures term structure could be a sign of added angst. He’s also eyeing the amount of cash in short volatility programs that wager on muted stocks swings: Investors shying away from such strategies could imply waning confidence in the low-volatility regime of late.
For the moment, a broad market hedge protecting against a sudden downturn remains cheap. Three-month puts protecting against a 10% drop in the S&P 500 are holding near multi-year lows, according to data compiled by Bloomberg.
“The high dispersion of stocks has contributed to weighing on VIX,” said Tanvir Sandhu, chief global derivatives strategist at Bloomberg Intelligence. “If the equity market breath improves then that may weigh on volatility, while a pullback in mega-cap tech stocks could see both correlation and index volatility rise.”
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