Elevated Dispersion Suggests Mechanical Market Reversal Lies Ahead

Stocks finished the day higher as implied volatility fell sharply on the VIX 1-day. That is unlikely to last, with Nvidia reporting results after the close tomorrow. It seems more likely than not that the VIX 1-day, which fell by 2.4 points to 12.7, will head significantly higher and will probably be closer to 20 by 4 p.m. tomorrow.

On August 27, when Nvidia reported fiscal second-quarter results, the VIX 1-day rose by 7.3 points to close at 15, and on November 19 it rose by 6 points to close at 26.9. A similar 6- to 7-point move higher in the VIX 1-day would mean it closes on Wednesday around 19 to 20. Notably, the S&P 500 finished higher on both occasions, rising by about 25 and 40 basis points, respectively.

Whether the market finishes up or down tomorrow will depend on how quickly implied volatility rises and how high it gets.

What seems clear, though, is that tomorrow there will be no volatility to crush. So if the market is going to rise, it will need to do so on its own merits, not with an assist from the volatility crowd.

Thursday will be a different story, with the high odds of a volatility crush regardless of what Nvidia does.

In the meantime, I would expect that after Nvidia reports, we begin to see the spread between S&P 500 constituent implied volatility and index-level volatility compress. Right now, that spread is extremely wide and has been so for some time. Anyone who reads this free daily commentary knows this is a seasonal earnings pattern, and it happens on a regular basis.

The last time the spread was this wide was in October and January 2025, as well as July 2024 and July 2023. Typically, those periods have been followed by sharp sell-offs in the market, and with the spread around 22, there is a good chance the same will happen this time as well.

In the end, this is all mechanical, and the mechanics show this is mean-reverting.

Finally, IG and HY credit spreads rose today, despite the S&P 500 moving higher, which is not something you see every day. CDS spreads for Oracle and other AI-related names continue to widen, and it would seem to me that IG spreads should be wider than they are, especially given that Oracle is an investment-grade name in the CDX IG index.

Mike

Glossary by ChatGPT

Basis Points: A unit of measurement equal to one one-hundredth of a percentage point, used to describe changes in interest rates or index performance.

CDS Spread: The cost of insuring against default on a company’s debt, expressed in basis points and used as a measure of credit risk.

CDX IG Index: A benchmark credit default swap index tracking a basket of North American investment-grade corporate debt issuers.

Credit Spread: The yield difference between corporate bonds and comparable maturity Treasury securities, reflecting perceived credit risk.

High Yield (HY): Corporate bonds rated below investment grade, offering higher yields due to increased credit risk.

Implied Volatility: The market’s forecast of a security’s future price fluctuation, derived from option prices.

Investment Grade (IG): Bonds rated BBB- or higher by major rating agencies, indicating relatively low credit risk.

Mean Reversion: A financial theory suggesting that asset prices or volatility levels tend to move back toward their historical average over time.

S&P 500: A market-capitalization-weighted index tracking 500 large U.S. publicly traded companies.

VIX 1-Day: A short-term volatility index measuring expected price fluctuations in the S&P 500 over the next one trading day.

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