image2 image2 image2

Equities signal calm waters, or do they?

PG
Peter Garnry

Head of Equity Strategy

Summary:  If equity market momentum and the VIX forward curve were the only two indicators worth looking at then one would be an optimist, but outside the spectacular momentum of mega caps, the equity market is signaling disruption. S&P 500 index concentration has risen to the highest levels on record and the mega caps outperformance is on par with previous major market turning points.


Key points in this equity note:

  • The VIX Index plunges to the lowest levels since March 2020 with the forward curve steepening suggesting the equity options market is betting on sustained momentum.

  • S&P 500 has never been more concentrated than today with the 10 largest stocks representing 30.4% of the index. This increases the risk and fragility in US equities.

  • Mega caps outperformance relative to the long tail of stocks in S&P 500 has reached levels seen during previous key turnings points in US equities.

VIX plunges to new lows

The VIX Index, measuring the 30-day expected annualized volatility in the S&P 500 Index, closed at 13.96 yesterday, a significant drop from 18 over just four trading sessions. This level was the lowest recorded in the VIX Index since the pandemic changed financial markets reflecting low levels of stress in US equities. There is a growing debate about the apparent calm equity market the past six months and the growing evidence of the economy slowing down and potentially headed into a recession. Many classical signals on the economy and especially those from the bond market are clear on the direction, but somehow the equity market is completely disagreeing.

The VIX Index itself has no predictability on future equity return, but the VIX futures forward curve has shown to improve return predictability. If we look at the spread between the 2nd nearest VIX futures contract and the VIX Index then the current spread is 3.4 points, which is right on the longer term average, the VIX forward curve is typically in contango (upward slopping). This level of contango is typically associated with positive equity returns so the equity options market is sending the signal that equities could extend their momentum. Earnings estimates are also reflecting the same optimism rising considerably throughout the Q1 earnings season as the outlook from companies has been much more optimistic than feared.

The US equity market has never been more concentrated

November 2021 marked a peak in US equity market concentration since 1991 although MSCI data suggests that the US equity market also experienced a dramatic peak in index concentration back in 1977. As the interest rate shock ran its course in 2022 pulling US technology stocks back to earth causing a significant reduction in the S&P 500 index concentration we were quite sure that the market had turned a corner in terms of index concentration. Never in our wildest imaginations would we have guessed that the index would roar back to new highs as of last Friday driven by an excessive AI-related rally in technology stocks. But the facts are what they are. The S&P 500 has never been more concentrated with the 10 largest stocks constituting a combined index weight of 30.4% as of last Friday. This is obviously not a good sign because it makes the US equity market more fragile and sensitive to small changes in sentiment in a few stocks. High index concentration also tends to be correlated with big breaks in financial markets as they transition to a new regime.

Source: Bloomberg and Saxo

Equities are reaching a turning point

While the equity indices are telling a different story than the one promoted by economists and the bond market there is one catch. The leading equity indices are all market-cap weighted. As the index concentration has risen so has the signal value from the equity market fallen, at least if you are only paying attention to the S&P 500. Beneath the surface of mega cap stocks the ocean of smaller stocks is telling a different story. The current is much cooler reflecting the realities in the economy.

The long-term relative performance between the S&P 500 and the S&P 500 Equal-Weight has been negative meaning that from the dot-com bubble days to around 2014 the equal-weighted index outperformed the market-cap weighted index. In other words, the smaller cap stocks outperformed. At around 2014 the cycle of index concentration accelerated and the S&P 500 has done better than the equal-weighted. The long-term trend is less important than the changes in the relative total return index over 26-weeks. Here we can see that S&P 500 has currently outperformed the equal-weighted index by 8.6% which is equal to the changes observed during the early days of the pandemic, the turnings points during the Great Financial Crisis (in November 2008 and March 2009), and during the LTCM crisis and the height of the dot-com bubble. So the market behaviour we are observing today has occurred during some of the most profound turning points in equity markets the past three decades. Where we go next is uncertain, but something big is happening under the surface of equity markets.

S&P 500 vs S&P 500 equal-weight | Source: Bloomberg and Saxo
Disclaimer

Saxo Capital Markets (Australia) Limited prepares and distributes information/research produced within the Saxo Bank Group for informational purposes only. In addition to the disclaimer below, if any general advice is provided, such advice does not take into account your individual objectives, financial situation or needs. You should consider the appropriateness of trading any financial instrument as trading can result in losses that exceed your initial investment. Please refer to our Analysis Disclaimer, and our Financial Services Guide and Product Disclosure Statement. All legal documentation and disclaimers can be found at https://www.home.saxo/en-au/legal/.

The Saxo Bank Group entities each provide execution-only service. Access and use of Saxo News & Research and any Saxo Bank Group website are subject to (i) the Terms of Use; (ii) the full Disclaimer; and (iii) the Risk Warning in addition (where relevant) to the terms governing the use of the website of a member of the Saxo Bank Group.

Saxo News & Research is provided for informational purposes, does not contain (and should not be construed as containing) financial, investment, tax or trading advice or advice of any sort offered, recommended or endorsed by Saxo Bank Group and should not be construed as a record of our trading prices, or as an offer, incentive or solicitation for the subscription, sale or purchase in any financial instrument. No representation or warranty is given as to the accuracy or completeness of this information. All trading or investments you make must be pursuant to your own unprompted and informed self-directed decision. No Saxo Bank Group entity shall be liable for any losses that you may sustain as a result of any investment decision made in reliance on information on Saxo News & Research.

To the extent that any content is construed as investment research, such content was not intended to and has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such, would be considered as a marketing communication.

None of the information contained here constitutes an offer to purchase or sell a financial instrument, or to make any investments.Saxo Capital Markets does not take into account your personal investment objectives or financial situation and makes no representation and assumes no liability as to the accuracy or completeness of the information nor for any loss arising from any investment made in reliance of this presentation. Any opinions made are subject to change and may be personal to the author. These may not necessarily reflect the opinion of Saxo Capital Markets or its affiliates.

Please read our disclaimers:
- Full Disclaimer (https://www.home.saxo/en-au/legal/disclaimer/saxo-disclaimer)
- Analysis Disclaimer (https://www.home.saxo/en-au/legal/analysis-disclaimer/saxo-analysis-disclaimer)
- Notification on Non-Independent Investment Research (https://www.home.saxo/legal/niird/notification)

Saxo Capital Markets (Australia) Limited
Suite 1, Level 14, 9 Castlereagh St
Sydney NSW 2000
Australia

Contact Saxo

Select region

Australia
Australia

The Saxo trading platform has received numerous awards and recognition. For details of these awards and information on awards visit www.home.saxo/en-au/about-us/awards

Saxo Capital Markets (Australia) Limited ABN 32 110 128 286 AFSL 280372 (‘Saxo’ or ‘Saxo Capital Markets’) is a wholly owned subsidiary of Saxo Bank A/S, headquartered in Denmark. Please refer to our General Business Terms, Financial Services Guide, Product Disclosure Statement and Target Market Determination to consider whether acquiring or continuing to hold financial products is suitable for you, prior to opening an account and investing in a financial product.

Trading in financial instruments carries various risks, and is not suitable for all investors. Please seek expert advice, and always ensure that you fully understand these risks before trading. Saxo Capital Markets does not provide ‘personal’ financial product advice, any information available on this website is ‘general’ in nature and for informational purposes only. Saxo Capital Markets does not take into account an individual’s needs, objectives or financial situation. The Target Market Determination should assist you in determining whether any of the products or services we offer are likely to be consistent with your objectives, financial situation and needs.

Apple, iPad and iPhone are trademarks of Apple Inc., registered in the US and other countries. AppStore is a service mark of Apple Inc.

The information or the products and services referred to on this website may be accessed worldwide, however is only intended for distribution to and use by recipients located in countries where such use does not constitute a violation of applicable legislation or regulations. Products and Services offered on this website is not intended for residents of the United States and Japan.

Please click here to view our full disclaimer.