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 (EPA:TTEF) 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.