Signage outside the Oracle offices in Redwood City, California.
(Bloomberg) — Stock investors don’t need to look hard to find warnings that the market looks frothy after a 36% surge from April’s nadir pushed valuations to levels associated with prior periods of exuberance.
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For much of the past two months, relative calm in the derivatives market has served as a handy retort to those worries, with Cboe’s Volatility Index clocking in well below its long-term average. Even under the hood, at the single-stock level, moves have been uncorrelated to a degree last seen in February – a sign of health to most market watchers.
That argument, though, suffered a blow recently when the VIX started creeping higher at the same time individual correlations remained muted. The VIX’s jump above 17 was viewed as a sign among derivatives traders that institutional investors are worried any stumble in the AI trade that’s powered gains all year could lead to a market-wide drawdown.
“One of the things I look for is, are the periods where they start to diverge, where VIX stops going down, even if correlations decline,” said Interactive Brokers Group Inc. chief strategist Steve Sosnick. “There is more nervousness out there, people are buying stocks but holding their nose. Don’t fight the tape, but insure against it.”
Dip buyers emerged Wednesday, when the S&P 500 rebounded from a sharp drop and the VIX slipped back below 17 on virtually no news. Tech led the way, as has been the case for the entire year. And that is the main reason for low correlation among single stocks: the outsize impact from the AI trade.
Huge gains in the likes of Oracle Corp. and Advanced Micro Devices Inc. drive the market higher, while slumps in consumer shares and perceived AI losers like Salesforce Inc. have kept breadth low. The concentration of gains in AI behemoths has left the virtually all of the S&P 500’s advance this year down to around 10 companies.
A few weeks before Apple Inc., Alphabet Inc., Microsoft Corp. and the rest of the tech giants report earnings, derivatives traders are adding protection in case any one of them misses the mark.
“If there is any disappointment there, the market does not have broader fundamental backing to help support these gains,” Sevens Report’s Tom Essaye and Tyler Richey wrote in a client note on Tuesday, referring to AI driven stocks specifically.
