Pro Perspectives 5/15/23

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May 15, 2023
 
A second meeting between the President and Speaker of the House, on the debt ceiling, is scheduled for tomorrow.
 
Thus far, McCarthy says "nowhere near" getting a deal done.
 
For the moment, the markets continue to assign a low probability of a negative outcome from the debt ceiling negotiations. 
 
The 10-year yield is at 3.5%, closer to the lows of the 90 basis point range of the year.  And stocks are trading closer to the high of the year's range.  And the VIX, looks like no fear …
The VIX tracks the implied volatility of S&P 500 index options.  This reflects the level of certainty that market makers have, or don't have, about the future.
 
To put it simply, if you are an options market maker, and you think the risk of a sharp market decline is rising, then you will charge more to sell downside protection (ex: puts on the S&P) to another market participant — just as an insurance company would charge a client more for a homeowner’s policy in an area more likely to see hurricanes.
 
An "uncertainty premium" would translate into the violent spikes in the VIX that you can see on the chart.
 
And as you can see, spikes are not too uncommon, especially in this post-pandemic environment. 
 
For now, the VIX appears to be signaling some relative calm.  
 
But this, low level in the VIX (lack of demand), might be the product of a market that is already very short, and very bearish (twenty-year extreme short positions from the leveraged futures traders, and global fund managers most bearish stocks, relative to bonds, since 2009).
 
So, the market position suggests expectations of more downside.  And that actually creates vulnerability to a sharp move higher. Why?  With some good news, the shorts (and those that are underweight equities) will be scurrying to reposition (long), which can exacerbate the move.
 
We're already seeing significant strength in big tech stocks (and the Nasdaq).  And a technical breakout level in the S&P 500 is nearby — this (white) line in the S&P 500 would be new nine-month highs … 
This, as the Fed tightening cycle should be over.  And stocks tend to do well at the end of tightening cycles. 
 

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