(Bloomberg) - For all the angst over US banking stress and a profit recession, none made it to the surface of the stock market in April.
Calm prevailed, with the Cboe Volatility Index ending the month below 16 for the first time since November 2021. The gauge, a measure of options costs also known as the VIX, slipped for six straight weeks as the S&P 500 endured its least turbulent month in almost four years.
As eerie as the market peace looked, it was the result of aggressive forces balancing each other out beneath the surface. Examples included the violent rotation between technology and financial stocks, and the collapse in lockstep moves among individual shares that sent correlation to a 17-month low.
Also at play was a growing divide in the actions of bulls and bears. Computer-driven funds lured by the market’s tranquility piled into stocks, while human traders mostly stepped back out of concern the worst is yet to come.
The forces offset each other, leading to what may be a false sense of peace. Chris Harvey, Wells Fargo & Co.’s head of equity strategy, likened the listless market to a teenager struggling to complete a set of pullups.
“He is nearing submission – but will not quit – determined to defy gravity just one more time, perhaps with the classic ‘flutter kick,’” he wrote in a note.
Confined in a 3% band during April, the S&P 500 just experienced its smallest monthly trading range since 2019. While stocks kept going up, the index did not reclaim the 4,200 level, a threshold that thwarted the market’s multiple attempts this year to break out.
Stocks weren’t the only asset beset with surface-level stasis in April. In fact, the S&P 500’s 1.5% move was the largest among indexes tracking Treasuries, investment-grade bonds, high-yield credit and oil. Not since 2019 has a month seen cross-asset movements as dull.
That was in stark contrast to last year, when almost everything fell victim to one big macro trade dictated by inflation and the Federal Reserve’s aggressive attempts to subdue it.
Underpinning the dormancy was the receding fear over inflation and a hawkish Fed. Consumer prices have softened for nine straight months. And the recent banking turmoil fueled speculation that the central bank may pause after another rate hike, which is expected Wednesday.
The fading angst was demonstrated by the performance of the Cboe 1-Day Volatility Index (ticker VIX1D) around inflation data and Fed meetings over the past year.
Last year, the one-day VIX — launched by Cboe Global Markets Inc. Monday to help capture sentiment following a trading boom in zero-day-to-expiry options, or 0DTE — regularly spiked in the session prior to either the release of the consumer price index or the Fed’s policy announcement. For example, on Dec. 12, right before the CPI print, the VIX1D surged to 47. By contrast, on the day before the last CPI, it closed near 19 on April 11.
“This trade of buying 0-1DTE expiry options for those events worked for several months in 2022 and has been a total bust for the last six months,” said Alex Kosoglyadov, managing director of equity derivatives at Nomura Securities International. “Volatility has been virtually non-existent in the broad-based equity market over the last couple of weeks.”
With the macro backdrop becoming less alarming, investors have turned their focus to individual companies, riding this earnings season on fundamentals.
As solid reports from big banks soothed nerves shaken by the collapse of multiple regional lenders, financial shares rallied for two weeks, while tech stocks — sought as haven during the banking turmoil — fell. Then as Microsoft Corp. and Meta Platforms Inc. reported results above estimates in the final week of April, tech bounced back, and financials retreated.
As a result of this kind of rotation, the lockstep moves during 2022’s bear market were largely gone. One-month realized correlation among S&P 500 stocks came into April near 0.5. Now, it’s below 0.2.
This swift rotation can be painful for wrongly positioned investors. Hedge funds, for instance, likely missed some of the latest tech rally. The group were net sellers of tech megacaps ahead of their earnings in the previous five weeks, according to data from Goldman Sachs Group Inc.’s prime brokerage unit.
But with losses in one area often offset by gains in another, the result has been a market that’s slowly grinding higher with volatility drifting down. That set the stage for diverging positioning among professional investors.
Systematic money managers, who make asset allocation based on momentum and volatility signals, have loaded up on global shares in the past month, driving their exposure to the highest level since early 2022, according to data compiled by Goldman Sachs.
Meanwhile, funds whose investment decisions are based on fundamentals are still resisting the rally. In fact, the equity exposure among overall hedge funds tracked by the firm in April sat in the bottom 1 percentile of a three-year range.
“It felt like a battle of Mike Tyson vs. Evander Holyfield, Tyson as a systematic investor, and Holyfield as a fundamental investor,” Scott Rubner, a managing director at Goldman Sachs, wrote in a recent note. “Flow of funds were literally offsetting each other in a daily ecosystem.”
By Lu Wang
