The S&P 500 finished roughly flat today ahead of the December jobs report on Friday, January 9, and a potential Supreme Court ruling on tariffs that could also come later that morning. As expected, the VIX 1-day rose to around 14, although that was somewhat lower than anticipated, given that it has typically moved into the mid-to-high teens in similar situations.

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Even so, this suggests that market volatility remains relatively low. While bond-market volatility also increased on the day, it too remains subdued, as reflected by the MOVE index. As a result, there is a risk that the market is not properly positioned for a potential outcome in which the tariffs are struck down and previously collected tariffs are repaid.

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Looking at today’s market rotation, it appears that investors were either covering short positions in staples or exiting long positions in technology. Alternatively, the moves may simply reflect positioning ahead of a potentially favorable ruling in which the tariffs are struck down. Staples rose sharply on the day, while technology stocks were hit hard for most of the session, leading to a notable divergence between the Nasdaq and the S&P 500.

At least when looking at the XLP-to-XLK ratio, there appears to be the potential for a change in trend. The ratio has broken its downtrend and may be in the early stages of a bottoming process. While it is still too early to confirm this shift, further upside in the ratio over the near term would help validate the idea that something may be changing in market rotation and in how investors are thinking about sector leadership.

Moreover, if tariffs were to be struck down, it would make sense for staples to outperform, as the sector would likely see cost relief and be better positioned to improve margins.

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While there is no clear reason for the energy sector to outperform technology as a result of tariffs, it does appear that any rise in oil prices could be positive for the sector. More importantly, given how small a percentage energy represents in the broader market, it likely would not take much rotation to push the XLE higher relative to XLK. In addition, a bullish divergence appears to have formed in the RSI of the ratio, and perhaps more importantly, the ratio itself is beginning to trend higher.

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It is also clear that part of this rotation is driven by a volatility dispersion trade, as earnings season begins next week with the banks. S&P 500 constituent implied volatility has been steadily rising, while index volatility has been suppressed.

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This has resulted in the 1-month implied correlation index falling to the lower end of its range, while the dispersion index has risen to the upper end of its range.

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The volatility compression is clearly visible in a chart of the NASDAQ 100, and any move to higher volatility is likely to lead to a significant decline in the technology-heavy index.

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