The S&P 500 Is Being Held Together With Glue, and the Cracks Are Showing

It was a tale of two markets. The cap-weighted and equal-weight indexes continued on divergent paths, and the SPY/RSP ratio fell 1.6% to 3.50, a level it has held every time it has tested this year. Above, 3.66 has now been rejected three times since November, and the third rejection has been the sharpest. If Amazon stays down tomorrow and 3.50 gives way, SPY is likely to keep underperforming RSP, with 3.37 the next level down.

The dispersion trade is also cracking, as anyone would guess. Earnings are passing every day, and single-stock implied volatility is falling faster than the VIX, which showed up in the 1-month implied correlation index rising 1.65 points on the day to 10.38

With all of that rotating around, it is no wonder the S&P 500 finished the day down just 30 bps while the RSP finished higher by more than 1%. At some point the rotations won’t be able to hold everything up, and the question is when, and how much damage is done when they stop. That isn’t easy to answer. But I do know liquidity is tightening. Overnight repo rates rose to 3.97% today, up from 3.91% on October 19, which means SOFR will probably print around there tomorrow, nearly 7 bps above IORB.

Reserves are back near $2.9 trillion, below the $3 trillion line that has mattered, and sitting at the low end of their range.

On top of that, T-bill issuance is still running, and that will keep draining liquidity and pressuring overnight rates.

At some point, all of this catches up to the market. CDS spreads are widening, liquidity is tightening, and the rotations are doing more work every day to hold the index together. The cracks are starting to show.

-Mike

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Glossary by ChatGPT

Cap-Weighted Index: A stock market index in which each company’s influence is determined by its market capitalization, giving larger companies greater weight.

Credit Default Swap (CDS): A derivative contract that provides protection against a borrower’s default, with its spread reflecting the market’s assessment of credit risk.

Dispersion Trade: An options strategy that typically involves buying individual-stock volatility while selling index volatility to profit from differences between constituent and index price movements.

Equal-Weighted Index: A stock market index that assigns equal weight to each constituent regardless of its market capitalization.

Implied Correlation: The average expected correlation among index constituents inferred from index-level and individual-stock options prices.

Interest on Reserve Balances (IORB): The interest rate paid by the Federal Reserve on eligible balances held by banks at Federal Reserve Banks.

Liquidity: The availability of cash and financing within financial markets, influencing the ease of funding transactions and absorbing changes in asset demand.

Overnight Repo Rate: The interest rate charged on short-term borrowing secured by securities, typically Treasury securities, through repurchase agreements.

Reserve Balances: Deposits held by eligible financial institutions at the Federal Reserve, representing an important component of banking system liquidity.

Secured Overnight Financing Rate (SOFR): A benchmark interest rate measuring the cost of overnight borrowing collateralized by US Treasury securities.

SPY/RSP Ratio: A relative performance measure comparing the market-cap-weighted S&P 500 ETF with its equal-weighted counterpart, used to assess market concentration and leadership.

Treasury Bills (T-Bills): Short-term US government debt securities with maturities of one year or less, whose issuance can influence money market liquidity and funding conditions.

Triple-Top Pattern: A bearish technical reversal formation characterized by three peaks near the same resistance level, with confirmation typically occurring after a break below support.

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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. 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.

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.