Have investors tired of their favorite themes? Over recent weeks, we have seen:
- SPAC issuance grind to a near-halt after a record pace
- The NASDAQ 100 Index (NDX) fail to retest the record highs reached a month earlier
- The Russell 2000 Index (RTY) experience a 10% correction within 10 days after a record high close
- Bitcoin fell over 20% from its record high in less than two weeks
- Late day weakness in major equity indices like the S&P 500 (SPX) over the past few sessions
While none of these are positive signals, they are not necessarily all that negative either. At least not yet. Few, if any, would dispute that we had been experiencing a bout of speculative frenzy. It is not unhealthy to see some profit taking in investment classes that had been seeing dramatic rises, especially if most of the major world indices are still higher for the year to date. The question going forward is whether this is part of a healthy and necessary nascent corrective process or the start of a changing trend.
It is always tricky to make a broad based call based upon a few days trading activity. What we will do instead is look at some of the macro factors that could influence markets beyond the short-term.
Bear in mind that President Biden signed the $1.9 trillion stimulus bill into law exactly two weeks ago, on March 11th. Bitcoin hit his record high level over the subsequent weekend. Over 90 million $1400 checks were direct deposited by March 17th. Does anyone care to guess when SPX last closed at a record high? I’ll give you a hint – it wasn’t just St. Patrick’s Day enthusiasm that pushed the market higher. Markets had been anticipating the arrival of stimulus and began pricing it in as the bill progressed through Congress.
As early as February 17th, we warned that the passage of the latest round of fiscal stimulus could be a “buy the rumor, sell the news” event. At that time, we noted that the VIX futures curve was pricing in a significant rise in volatility for the spring and summer months. We attributed that to a combination of the “sell the rumor” mindset, combined with a fear that markets would experience drawdowns when traders and investors who had significant profits in 2020 had to pay their taxes. Let’s take a look to see how the market has changed its volatility assumptions since then:
VIX Futures Curves: Today (orange), March 11 (green), February 17th (blue)
We can see that the curves have shifted lower throughout the past few weeks. Part of that is likely related to the fact that tax deadlines have been pushed out a month to mid-May from mid-April. Another part is that with the “buy the rumor” part of the stimulus trade behind us, there is less need to worry about the “sell the news” part. Remember, VIX is a 30 day look-ahead, and we’re less than a month into the process.
While I have stated repeatedly that I do not subscribe to the idea that VIX is the market’s “fear gauge”, I do find the relative complacency to be perhaps the clearest warning sign that this corrective phase could continue. While some of the recent rise in VIX was the result of speculative call buying, we noted yesterday that much of the recent decline in that index was because traders showed reduced demand for protective puts rather than a lack of enthusiasm for calls. Volatility can often be a contrarian indicator. Buying opportunities often present themselves when implied volatilities and VIX reach extreme levels, while selloffs can materialize seemingly out of nowhere when implied volatilities are low.
We explored that concept earlier this month, when VIX was higher than it is now. The lack of fear displayed by investors then was rewarded in the short term – despite a couple of hairy days that we saw shortly after the piece was written – but now we have to wonder whether markets are even more sanguine in the face of some selling. My main concern is that markets could continue to struggle for as long as investors remain unconcerned by that struggle. It sounds like a bit of pretzel logic, but sometimes a winding path is the correct one for traders.
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