The VIX Hits A 5-Month Low, But Market Correlations May Herald Near-Term Consolidation Of Equity Rally

Past the midway point in the trading week and the major averages have bounced back from consistent selling in the previous week and what many thought may prove a period of continued market consolidation and/or retrenching.  Even with Boeing (BA), the most heavily price-weighted stock on the Dow Jones Industrial Average (DOW), proving a major headwind, the index is higher week-to-date and finished up .58% on Wednesday. The S&P 500 (SPX) and Nasdaq (NDX) both finished .69% higher on Wednesday as well. 

The rally in equities continues, even with a rally in bonds, which finds yields lower YOY. The 10-year Treasury yield (TNX) ticked higher Wednesday but is still hovering near lows not seen since January 2018. Additionally, the typical inverse relationship between bond yields and equity prices has continued for a longer period than most investors would care to see. We can review the divergence in the chart comparison of 10-year Treasury yield and S&P 500 below. The divergence has persisted since the onset of the equity market rally in the New Year.

The breadth of the investor and analyst community suggests that the current divergence in correlation will likely prove negative for stocks. But when…

With the equity market bounce back this week, complacency has crept back into the market, as gauged by the VIX . The so-called fear gauge fell to a 5-month low during Wednesday’s trade, finishing the day at 13.41. Just over 1.2 million VIX options contracts traded on the day. 

In terms of market breadth, its pretty much split down the middle with respect to index ETF breadth. Half of the major index ETFs are Overbought while the other half are still Neutral. On a sector basis, Utilities are approaching extremely Overbought levels.

Based on the lack of volume and hedge fund positioning throughout the market rally leaning defensively and with limited exposure to cyclicals, it probably comes as no surprise where individual stock groups stand relative to their highs. Just as the Utility sector is the most overbought sector, groups within the sector recently hit 52-week highs. As shown below, Water, Multi, and Electric Utilities all hit 52-week highs on Tuesday and closed out the session less than 1% from those highs.

There’s no viable way to sugarcoat this market rally and to suggest it shows itself to be a healthy one would require a strong bias.  Nonetheless, when the algorithms take hold they can prove to push a rally or decline further than many think possible, seeking out levels as they navigate capital in and out of sectors. And speaking of capital flows, last week found ETFs with another week of outflows.

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