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Despite a recent uptick to a more normal level near 16, the Cboe Volatility Index (VIX) has averaged around just 12.8 over the past 30 trading days as of July 18, indicating relative calm in U.S. equities. Meanwhile, a complementary measure of U.S. equity market risk, the CBOE S&P 500^® Dispersion Index (DSPX), has surged to multi-year highs in the mid-thirties—suggesting the market expects unusually large swings in single stock prices during earnings season.

Typically, DSPX is positively correlated to VIX, so when VIX is high and the S&P 500 is experiencing large day-to-day moves, underlying stocks tend to have larger swings and therefore higher dispersion. For example, both VIX and DSPX reached their all-time highs during the height of the COVID-19 selloff in March 2020. Additionally, DSPX tends to rise somewhat during earnings season as traders anticipate greater idiosyncratic performance of companies as earnings reports are released.

That said, a particularly unusual aspect of the current environment is how high implied dispersion is compared to implied volatility. In fact, the spread between DSPX and VIX recently reached an all-time high stretching back to the beginning of the back-tested history of DSPX in 2014 (see Exhibit 1).

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A key driver dampening overall U.S. market volatility of late has been historically low correlation. In fact, the correlation between the S&P 500 constituents fell to a rare 0.06 for the month of June, indicating stocks have often been moving in divergent directions. Likewise, the Cboe 3-Month Implied Correlation Index—which measures the market’s expectations for the S&P 500 index constituent correlation based on options prices—reached all-time lows over the past few weeks.

The high-dispersion and low-correlation environment has been visible in several corners of the market even for casual observers. For example, Information Technology stocks have rocketed higher over the past year—with those being viewed as the major beneficiaries of AI, like Nvidia, experiencing the largest gains within the sector. On the other hand, Real Estate, Energy and Materials stocks have significantly lagged the broader market over this period. Interestingly, over the past few trading sessions, we’ve seen a reversal in leadership, with Info Tech stocks sinking while Energy and Real Estate have experienced gains.

Important to note is that the current dynamic is an extension of a trend that has been playing out over the past few years. Exhibit 2 illustrates the transformational shift in risk dynamics of U.S. equities over the past five years. VIX reached its all-time high during the height of the pandemic selloff in March 2020 as macro events overwhelmed underlying fundamental drivers of risk. As we emerged from the pandemic and markets calmed, we started to see more pronounced divergence in sector and stock level performance. That trend has continued to intensify, bringing us to where we are today with idiosyncratic factors overpowering macro risk.

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With the U.S. presidential election taking place in less than four months, it will be interesting to see how the risk landscape in U.S. equities may further evolve. However, one thing is true, VIX continues to be the most essential gauge of market volatility, and using a range of equity market risk indicators—such as DSPX—can provide deeper insight into the volatility landscape.

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