Over the past week, we have highlighted several market indicators which we – and many others – have found surprising – and concerning – about the euphoric risk rally in the new year (including record overbought RSIs, near record stretched retail sentiment, very positive analyst earnings revisions, a record period of time without a 5% correction, and very low pairwise correlations within equity indices).
We can now add one more way in which recent market sessions “have displayed odd cross-asset price action” as Citi’s Jeremy Hale writes.
According to the cross-asset strategist, while the S&P 500 has rallied to new highs, credit spreads have widened slightly of the tights…
… and implied equity vols have also increased.
As Hale adds, “the latter is especially odd and usually only occurs in an equity market dip, at least a small one, and not a rally.”
There are other odd observations: as Bank of America pointed out last Friday, while stocks across the world have had a strong start to the year, levitating higher on record bullish sentiment investors have been pulling money out of junk-bond funds on concerns about the impact of higher interest rates.
So what’s going on here? Well, according to Hale, who puts on his “devil’s advocate” hat on, “one could argue that the credit price action is part of a move to the third stage of the ‘credit clock’ and that the move in VIX makes it a good hedging tool for equity longs. On the former, we would argue that the credit clock has been fleeting in its real-life usability, with the stocks/credit relationship often changing – see more here. And as we have shown. VIX hedges are very costly and historically, absent perfect timing, have shown limited use for hedging equity longs over long periods.”
As such, Citi is “monitoring the moves in credit and equity vol as another potentially bearish tactical signal for stocks.“