Despite Friday’s sharp decline, many of the metrics and positioning indicators we have been tracking did not show a meaningful improvement. Even with the S&P 500 falling by roughly 2.6%, the 3-month implied correlation index rose to only 12.2, which remains historically low. This suggests that the risk remains skewed toward correlations moving higher and dispersion moving lower.
Dispersion remains near a seasonal turning point and appears long overdue for a reversal lower.
How this ultimately resolves will depend largely on whether index volatility continues to rise or single-stock volatility begins to fall. Based on Friday’s price action, index-level volatility increased sharply, while single-stock volatility rose by a much smaller degree.
If we are in the middle of an unwind of the dispersion trade that began at the start of May, then the process is likely not over. We would need to see single-stock volatility decline considerably further, while index volatility either remains elevated or declines more slowly.
The key point is that implied volatility for semiconductors remains very high across the board. It is also clear that while index skew has moved back toward a more neutral position, single-stock implied volatility remains elevated, particularly within the semiconductor sector.
So, if Friday’s decline was largely mechanical in nature and driven by the unwinding of the dispersion trade, then those mechanics likely still have further to run.
Technically, Friday’s decline did some meaningful damage, with the S&P 500 breaking below its 20-day exponential moving average. That could be an early warning sign that market conditions are beginning to change. It is the first time the index has fallen below this moving average since early April.
If the S&P 500 cannot quickly reclaim that level on Monday, it would suggest that the recent pullback may have further to run.
Additionally, my CTA tracking model suggests that systematic funds are either very close to or have already begun reducing exposure. The sizable sell imbalance on the on Friday could indicate that a systematic selling trigger has already started. That said, this conclusion is based on my model and should be viewed in that context.
This week will also bring the report, and given the market’s reaction to Friday’s , I would expect investors to take this release much more seriously. As I noted on Thursday, the closed below 11, suggesting the market was largely unconcerned about the jobs report. Clearly, that proved to be the wrong assessment.
I suspect the VIX 1-Day Index will be trading at a much higher level heading into this week’s CPI report. On Friday, it closed at 28.7, suggesting that once the market opens on Monday, we could see some degree of a volatility crush. The bigger question, however, is where the market will be trading when it opens and how much of a crush will follow.
One thing the market may have going for it this week is that we are flipping back to Treasury paydowns, while mid-June tax receipts begin to arrive. On June 9, the Treasury is scheduled to pay down roughly $5.1 billion in , and net bill issuance for June 11 is expected to be around zero, with a coupon settlement of approximately $79 billion on June 15.
That shift should provide at least some support for , which has been under significant pressure since issuance turned higher in mid-May. I do not know whether the paydowns will be enough to drive a meaningful rally, but Bitcoin is currently trading below its lower Bollinger Band, and the RSI is well below 30 after breaking down from its March lows.
At a minimum, a rebound or period of sideways consolidation appears overdue, and this shift in liquidity dynamics could create a window of opportunity for it to occur.
One potential negative is the upcoming IPO, which could drain liquidity from multiple corners of the market. Given the size of the offering, investors may need to reallocate capital from existing positions to participate, creating a temporary liquidity headwind for other assets.
Additionally, if the rumors that is considering an equity offering prove to be true, it could create an even larger liquidity drain. Combined, these transactions could absorb a meaningful amount of capital at a time when market liquidity is already under pressure. More importantly, the Treasury paydowns scheduled over the next couple of weeks are unlikely to be large enough to offset the liquidity that could be absorbed by a major IPO and a sizeable secondary offering.