Equities are going nowhere and somewhere all at the same time.
Summer can be drudgery and melt-ups monotonous. As August dawned scorching, markets meandered languid in a listless sideways drift that’s had just enough of an upward bias to put record highs for the world’s benchmark risk asset par excellence within reach.
Although US shares briefly snapped out of the daze last week (when a Nikkei headline tipping the BoJ’s decision to widen the allowable band for 10-year JGB yields conspired with hot US data to trigger a bond selloff), stocks have all but “stopped moving,” as Nomura’s Charlie McElligott put it Tuesday.
The range compression illustrated above has driven vol down to extremes — one-month realized is 1%ile. So is three-month realized on a one-year lookback.
During the crash-up days earlier this summer, selling puts was the way to go. Call-selling, not so much, as the panicked grab into equities post-Nvidia and post-debt ceiling resolution found spot habitually breaching short strikes on overwriters’ calls.
Now, with markets shuffling sideways, short vol isn’t just about selling puts into a market that never falls anymore.
“It’s now become an index range compression trade,” McElligott went on to say, noting that “the prior multi-month crash up / spot up / vol up dynamic has finally paused [and] we are now back to an environment where index close[s] within the daily straddle band.”
As Charlie noted in the annotations on the left-hand chart above, spot was breaking through the upper-end of the range frequently (more than 40% of the time, at one point). Now, with the crash-up behind us and the rally morphing into a sleepy drift, the dynamics for overwriters (i.e., relative profitability versus put-selling) are less challenging.
If you ask JPMorgan’s Andrew Tyler, who runs the bank’s US market intelligence team, it “feels inevitable” that the S&P will ultimately “tak[e] out the all-time high.” I don’t know what would’ve given him that idea. Other than US equities rallying to within 4% of that same all-time high. (I’m just joking, Andrew. All in good fun.)
It’s possible, he wrote, that equities could give some back in August, but by next month, the favorable growth backdrop, solid earnings and “visibility” around the end of the Fed’s hiking cycle “should be supportive” for stocks.
And then there’s positioning. Although we’ve seen “some capitulation,” many bears are just now neutral, “not outright bullish,” Tyler said, citing pervasive macro ambiguity and the psychological overhang from the platitude that says Fed hiking cycles “always break something.”
It’s worth noting (I guess) that 43% of JPMorgan clients expect stocks to hit new records this year. A combined 56% say new highs are coming by the end of 2024.
“It does appear there is money on the sidelines waiting for an opportunity to come into US stocks,” Tyler went on.
Commenting further on Tuesday, Nomura’s McElligott said equities positioning and flows appear to “confirm massive FOMO” and a “‘beta-grab’ to get exposure back on” after so many investors were underweight based on bearish macro views that simply failed to pan out.
