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.