Institutional Insights: Nomura 'Nasty S&P Backtest'
Market Overview:
The index appears calm, but individual stocks show significant volatility. Historically, such extremes often precede negative S&P 500 returns 2-3 months later, even if the short-term outlook seems stable.
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1) Rates: Labor Market Concerns
- Market Behavior: USTs/SOFR suggest the market is short duration/rates, creating vulnerability to sudden moves.
- Drivers of Nerves: Weak labor data (JOLTS, ADP), potential payroll revisions, and admin commentary hinting at weakness.
- Options Signal: Heavy skew to OTM receivers reflects fears of labor shocks leading to growth concerns and falling yields.
Takeaway: Rates markets are pricing in labor downside risks, signaling potential bond rallies.
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2) Equities: High Dispersion, Low Correlation
- Key Observations:
- SPX flat since mid-Jan, but average stock moves ~10.8%.
- Low correlation (~9) boosts dispersion (idiosyncratic moves) and suppresses index volatility.
- Outcome: Violent single-stock swings offset each other, making the index appear calm.
3) Causes of Dispersion:
1. Factor Rotation: Shift from Mag7/AI to Value/Cyclicals/Defensives.
2. Crowded Positioning: High leverage and rapid de-risking in multi-manager strategies.
3. Options Impact: Short-dated options and leveraged ETFs amplify single-stock moves.
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4) Historical Warning:
- Extreme dispersion (~99th percentile) historically leads to:
- t+1 month: Stable returns.
- t+2 to t+3 months: Median SPX returns turn negative, with potential drawdowns.
- 1 year: Returns remain weak.
- Dispersion often signals unstable positioning and macro stress, which can resolve with broader risk-off moves.
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5) Trading Takeaways:
- Don’t be misled by SPX calm; watch for delayed downside after extreme dispersion.
- Dispersion trades (long single-name vol/short index vol) have worked during these periods.
- Be cautious of correlation snapping back during risk-off events, which could spike index volatility.
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Key Points Summary:
- Rates: Hedging labor downside risk; fear of yields dropping on growth concerns.
- Equities: Index calm masks extreme single-stock dispersion.
- History: Extreme dispersion often precedes negative SPX returns 2-3 months later.
- Risk: Correlation shifts during risk-off could trigger rapid index volatility.
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Past performance is not indicative of future results.
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Patrick has been involved in the financial markets for well over a decade as a self-educated professional trader and money manager. Flitting between the roles of market commentator, analyst and mentor, Patrick has improved the technical skills and psychological stance of literally hundreds of traders – coaching them to become savvy market operators!