It could take just a 1% move in the S&P 500 — up or down — every day for a week for the rally in US stocks to come under significant pressure.
(Bloomberg) — It could take just a 1% move in the S&P 500 — up or down — every day for a week for the rally in US stocks to come under significant pressure.
That’s according to data from Nomura cross-asset strategist Charlie McElligott, who said the exposure of volatility-control funds to equities was so high that the risk of a selloff had surged following calm trading in recent months.
These risk-parity funds tend to pile up stocks when they rally during periods of low volatility, forcing them to unwind when trading becomes more choppy — regardless of whether the market is rising or falling. The last time the S&P 500 fluctuated by more than 1% a day for a whole week was at the start of February, the index’s only negative month so far this year.
The “asymmetry” between the potential for selling from these funds versus buying further is “enormous,” McElligott said in an email. A daily move of plus or minus 1% in the S&P 500 for one week would force about $28.8 billion worth of selling, he said. That compares with just about $2.3 billion of buying that would accrue from sideways travel.
To be sure, the US stock market has been relatively calm since the banking turmoil in March, when a string of bankruptcies in regional lenders fanned worries about the health of the global financial system. While the CBOE Volatility Index showed small spikes in May as the US faced an unprecedented debt default, it settled lower fairly quickly in the following weeks. The S&P 500 itself has gained 16% so far this year.
One major test for the sense of calm will come later Thursday from key US inflation data. Investors have relied on the monthly figures for clues to the Federal Reserve’s policy outlook, and any signs of sticky price pressures could shake up wagers of a potential peak in interest rates. Economists surveyed by Bloomberg expect the report to show the first year-on-year acceleration since June 2022.
The S&P 500 has posted moves of plus or minus 1% following the data eight times in the past 18 months, although investor reaction this year has been fairly subdued, according to data compiled by Bloomberg.
And while history is no indication of the future, an analysis of the S&P 500’s performance in 2019 — the year that closely resembles US stocks’ current trajectory, according to Morgan Stanley strategist Michael Wilson — shows the index’s five-day rolling average move was the highest in August of that year. The benchmark had posted a decline of 1.8% that month, although it still ended the year with gains of nearly 29%.
“Any sustained period of rising prices and falling volatility leaves these kinds of strategies extremely susceptible to a reversal of both trends, and makes the broad market susceptible to such shifts as well,” said James Athey, investment director at Abrdn.
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