It’s fair to say the melt-up materialized.
That’d be the equity melt-up I spent the better of May and June hinting at and alluding to even as (too) many “professionals” insisted that tariff uncertainty and the outbreak of full-on war between Israel and Iran all but precluded a run to new all-time highs for US stock benchmarks.
This isn’t an “I told you so” moment for the sake of it. Rather, it’s a reminder that — and I realize this is ad nauseam for regular readers — equity prices are no different from any other prices in being a function of supply and demand.
On the demand side, rampant trade uncertainty perversely helped bolster stocks by compelling corporates to favor buybacks over other cash usage alternatives. Meanwhile, the reset lower in trailing realized volatility (off the “Liberation Day” panic spike) served to embed in the market a latent bid for risk exposure from volatility-targeting, systematic strategies which scaled back into equities as the range of daily spot outcomes compressed.
Throw in retail participation, and the supply-demand equation leaned heavily in favor of demand, biasing stock prices to the upside. It’s just that simple, folks. If demand outstrips supply, then prices will generally rise. The fact that a few dozen Iranian nuclear scientists and high-ranking IRGC officials were incinerated and/or that heads of state the world over lost a lot of sleep (and maybe a lot of hair too) fretting about Trump’s tariffs, didn’t do anything to change that bullish supply-demand math.
And so, here we are. Where? With a sub-15 VIX and SPX near enough to 6400. Although the headline Friday was that the S&P rose every day this week on the way to a succession of new highs, the most important data point is 22. That’s the number of sessions the benchmark’s gone without a move of 1% or more in either direction (see the purple shaded area in the chart, below).
As the figure shows, 10-day rVol now sports a five-handle. The three-month metric is below 12, having collapsed from 30 at the beginning of the month (see the grey shaded area in the chart).
That latter point’s key. The wild sessions around “Liberation Day” dropped in July from the three-month rVol lookback. Assuming no new shocks, model-based buying from strategies which incorporate that three-month metric was preordained. That is: Guaranteed equity demand.
Now what? Well, that’s a good question. Thankfully, I addressed it at some length on Thursday in “Before The Fall, A Blow-Off Top?” which I means I don’t have to recapitulate here, on a Friday evening. It’s enough to say that next week’s chock-full of event risk, but between renewed corporate demand and a little bit left in the tank for the bullish July SPX seasonal, there’s some scope for this parade to continue.
That said, the return of the meme stock mania and general signs of “froth” are a yellow light, if you will. And as BofA’s Michael Hartnett remarked, de-regulation and macroprudential easing can fuel bubbles, particularly “in late-stage bull markets.”
The Trump administration’s “finalizing an executive order to allow private equity into 401ks and FINRA’s ‘defanging’ the Pattern Day Trading Rule to allow retail investors to day-trade via reduced minimum margin accounts,” Hartnett wrote, cautioning on more retail participation, more liquidity, more volatility and bigger bubbles. 0DTEs, he remarked, have constituted more than 60% of S&P 500 options activity in Q3 so far.
Now what?
Good boring hopefully
Many old-timers continue to cling to the notion that if “valuations” continue to get further stretched selling will eventually follow. Based on long discredited rules of investing. Look at value versus growth in this century.
I have little trust in this rally but have to ask myself what can (not will) turn stocks lower. The only factor I see is increased share or bond sales from foreign investors which just might tip the vol-driven algo models. The bond market’s tepid reaction to Trump’s endorsement of a weaker dollar this morning is making me rethink that as well.
Yet I am bothered that the $115 BILLION of buying flagged by McElligott and Rubner has not proven to be even more of an accelerant? WHO is selling into this?? Might it be foreigners?
If it is one or a few whales offloading shares, the skillful execution points to one or more sovereign wealth funds. There’s an art to unloading large positions without panicking the markets.
Could just be selling from overwriters stuffed on gargantuan amounts of calls from buy-write ETFs. You mentioned McElligott, and the last update from him (by which I mean the last update about him written here, I don’t receive his notes) suggested we’re deep in +gamma territory.
Could be, but the size being moved suggests otherwise. Most dealers run a matched book with dynamic hedging on a daily or shorter basis.
Especially in this environment. But I’m not deeply involved in that world anymore.
Inflation caused by currency debasement from printing lots of USD’s has been given a “green light” for the long term. The BBB cemented that; spending in excess of taxes collected will be occurring regardless of which party is in office. No more Republicans wanting a balanced budget! Also, the USA will be printing USD’s at a far faster pace than the pace of economic growth.
Therefore, in times of inflation caused by currency debasement (as opposed to inflation originating from supply/demand imbalances), what would I want to own?
At the top of my list would be equities and real estate in drop dead geographically gorgeous/ supply constrained locations.
Really not bonds. Even Mr. Lucky is worried about people who put their retirement savings in long term bonds.
Even the real estate is getting to be an issue. As the owner of some property in a drop dead geographically gorgeous/supply constrained location, we are looking to sell because insurance coverage is becoming very difficult to obtain and very expensive and this is for a non-California, non-coastal area. I am pretty much down to widely diversified equities.
I am more worried about localities prohibiting short term rentals.
“At the top of my list would be equities and real estate in drop dead geographically gorgeous/ supply constrained locations” – having just come back from a trip to Switzerland , I do believe that country fits your description perfectly
Sure feels like we’re not in Kansas anymore. Will the masses wakeup when the next Executive Order ordains all citizens must register with the Lollypop Guild. Apparently suggesting the Kennedy Center become The First Lady Melania Center didn’t even make a dent.
Vol strategy funds are at ~55% allocation with head room to 70%. Summer volume is super low, with ES futures reaching only 700000 contracts yesterday. That’s half the normal 1.4m. Vols are still compressing. Earnings appear to be fine with profits appearing healthy and pricing power unperturbed thus far.
The tariff taxes on US consumers has only begun to show in the numbers. Bong vigilantes remain vigilant but still holding back. Now there’s additional demand for US notes and treasuries as crypto stable coins load up on “riskless” bonds to lever their newly legal threats to the financial system. That crypto is now tethered to US debt certainly will raise eyebrows at coin vol pass through to legacy instruments.
I think it will take more time for these still fresh government actions to actually hit markets. And the current administration only cares about how they will personally gain and will abandon the despised government to the bail the system out and failure when it’s time to laugh it all off as a great con at a resort in Malta.
Watch the consumer and margins, as H has pointed out. Meanwhile, enjoy getting wealthier. It’s your only protect from tyranny.
Do you mean their equity allocation is capped at 70%?
Bong vigilante… ? That was me once!
Thanks, H, for helping us navigate the treacherous waters between Scylla and Charybdis. Your analysis and insight have been particularly helpful during these tumultuous times. (Not meant as advice, freeze or refrigerate before expiration, not to be used as a children’s toy)
Is it a known fact that vol target strategies use 3 months look back instead of exponential moving average?