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The S&P 500 rebounded on Friday following Thursday’s chaotic trading session. Friday’s rally appeared mostly mechanical, driven by volatility levels resetting after the jobs report. As volatility settled down, the cash market effectively stalled out.
Oddly, many unusual dynamics are unfolding in the volatility space, particularly concerning correlations and the substantial gap between realized and implied measures. Surprisingly, 3-month realized correlations currently hover around 50, while implied correlations sit closer to 24, creating a wide gap of about 26 points. This disparity suggests that the market anticipates a significant decline in correlations. However, the actual trend suggests otherwise, as the realized correlation continues to rise, implying correlations are not only elevated but still strengthening.
It suggests there’s a high degree of complacency in the market. Interestingly, the last time we observed a realized correlation spike, which then remained elevated, was during the March 2022 rally, following the February lows.
A similar event occurred following the August 2024 sell-off, but that episode was brief, and correlations remained notably lower than what we’re seeing today.
Additionally, we’ve seen 10-day realized volatility in the S&P 500 return to recent lows, around 9 to 10—levels that have marked the volatility floor since February. While it’s possible volatility could drift even lower, as it did in the summer of 2024, ongoing news flow and daily headline risk likely make the current area around nine a more realistic baseline. This translates into typical daily S&P 500 moves of roughly 50 to 60 basis points, with any moves beyond that threshold driving realized volatility higher.
In the meantime, BTIC S&P 500 Total Return Futures continue to diverge from the rising S&P 500 index. Notably, BTIC futures have been trending lower since the cash index bottomed back in April.
Obviously, these conditions don’t pinpoint exactly when a market pullback will occur, but they clearly indicate that complacency is high, and it won’t take much to shift sentiment. Although Friday didn’t deliver the downward move I was anticipating, it’s unclear if the bulls accomplished anything meaningful either. Essentially, the market closed near the top of the recent trading range and may have completed an ending diagonal triangle. If this count is correct, we should see the market start to decline on Monday without looking back. If it’s incorrect, it should become evident very quickly.
We also saw the 10-year yield break out of a bull flag pattern on Friday. Given this bullish setup, it seems likely the 10-year rate will continue to rise. If it can clear the 4.61% level, there could be significant upside ahead.
Have a good Monday.
-Mike
Terms By ChatGPT:
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BTIC (Basis Trade at Index Close)
A futures contract trading method where the price is determined based on the official closing price of the underlying index.
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Ending Diagonal Triangle
A technical chart pattern (Elliott Wave Theory) that often signals a reversal in trend. It’s characterized by converging trendlines and overlapping price movements, usually occurring at the end of a sustained upward or downward move.
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Bull Flag Pattern
A bullish continuation pattern that occurs after a sharp upward price move, consisting of a short-term downward or sideways consolidation before the trend resumes upward.
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Implied Correlation
A measure derived from options pricing, indicating market expectations of future correlations between individual stocks within an index.
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Realized Correlation
The actual observed correlation among stocks within an index, calculated from historical price data.
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Gamma Levels
A measure from options trading indicating the rate of change of an option’s delta relative to movements in the underlying asset price. It often influences volatility and hedging behaviors.
This report contains independent commentary to be used for informational and educational purposes only. Michael Kramer is a member and investment adviser representative with Mott Capital Management. Mr. Kramer is not affiliated with this company and does not serve on the board of any related company that issued this stock. All opinions and analyses presented by Michael Kramer in this analysis or market report are solely Michael Kramer’s views. Readers should not treat any opinion, viewpoint, or prediction expressed by Michael Kramer as a specific solicitation or recommendation to buy or sell a particular security or follow a particular strategy. Michael Kramer’s analyses are based upon information and independent research that he considers reliable, but neither Michael Kramer nor Mott Capital Management guarantees its completeness or accuracy, and it should not be relied upon as such. Michael Kramer is not under any obligation to update or correct any information presented in his analyses. Mr. Kramer’s statements, guidance, and opinions are subject to change without notice. Past performance is not indicative of future results. Neither Michael Kramer nor Mott Capital Management guarantees any specific outcome or profit. You should be aware of the real risk of loss in following any strategy or investment commentary presented in this analysis. Strategies or investments discussed may fluctuate in price or value. Investments or strategies mentioned in this analysis may not be suitable for you. This material does not consider your particular investment objectives, financial situation, or needs and is not intended as a recommendation appropriate for you. You must make an independent decision regarding investments or strategies in this analysis. Upon request, the advisor will provide a list of all recommendations made during the past twelve months. Before acting on information in this analysis, you should consider whether it is suitable for your circumstances and strongly consider seeking advice from your own financial or investment adviser to determine the suitability of any investment.
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This report contains independent commentary to be used for informational and educational purposes only. Michael Kramer is a member and investment adviser representative with Mott Capital Management. Mr. Kramer is not affiliated with this company and does not serve on the board of any related company that issued this stock. All opinions and analyses presented by Michael Kramer in this analysis or market report are solely Michael Kramer’s views. Readers should not treat any opinion, viewpoint, or prediction expressed by Michael Kramer as a specific solicitation or recommendation to buy or sell a particular security or follow a particular strategy. Michael Kramer’s analyses are based upon information and independent research that he considers reliable, but neither Michael Kramer nor Mott Capital Management guarantees its completeness or accuracy, and it should not be relied upon as such. Michael Kramer is not under any obligation to update or correct any information presented in his analyses. Mr. Kramer’s statements, guidance, and opinions are subject to change without notice. Past performance is not indicative of future results. Neither Michael Kramer nor Mott Capital Management guarantees any specific outcome or profit. You should be aware of the real risk of loss in following any strategy or investment commentary presented in this analysis. Strategies or investments discussed may fluctuate in price or value. Investments or strategies mentioned in this analysis may not be suitable for you. This material does not consider your particular investment objectives, financial situation, or needs and is not intended as a recommendation appropriate for you. You must make an independent decision regarding investments or strategies in this analysis. Upon request, the advisor will provide a list of all recommendations made during the past twelve months. Before acting on information in this analysis, you should consider whether it is suitable for your circumstances and strongly consider seeking advice from your own financial or investment adviser to determine the suitability of any investment.
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