Stocks managed to rally yesterday, with the S&P 500 up almost 75 bps. With a large portion driven by the usual suspects. The rally in stocks continues as credit spreads narrow and financial conditions ease. This has allowed implied volatility to be sold and stocks to rally. The trade mechanics are similar to what we saw in June and July.
Interestingly, the 1-month implied correlation index rose yesterday and, over the last few weeks, has fallen back to what has historically, over the past five years, been the lower bound of this index, and typically, this area of 17 to 19 marks short-term tops in the stock market. Some of those tops have been minor and, in some cases, large. It is merely meant to be an indicator to tell us we are in a range that could support a move lower in stock prices.
It may be rising because the 1-month implied volatility of the top 7 stocks in the index is falling along with that of the S&P 500. So, the correlation in implied volatility for stocks is going in the same direction as the S&P 500, which means they are more correlated to the index.
Additionally, the VIX is back to the low end of the range, dropping below 14 yesterday and trading down to around 13.5.
The CDX high yield index is also back to the low end of its range between 400 and 410. Over the past 2-years, this level has supported the index and marked tops in the S&P 500. Now, realize this CDX high yield index could also be viewed as a measure of financial conditions, and when the index is falling, it means conditions are easing.
So, the drop below 400 in periods like 2020 and 2021 happened during periods of easy monetary policy, while periods that saw spikes were during periods of stress or tighter policy. Since we are in a periodRead more on investing.com