Bloomberg Intelligence commented that investment linked to AI had another bad day on Tuesday, with the Nasdaq 100 index reflecting the setback of South Korean chip manufacturers. And yet, the US volatility indicator barely flinched. This is typical of this market: much drama but none of it seems to affect the core of the system.
The S&P 500 index is near an all-time high and practically at the same level as mid-August. Two months of headlines, but without significant progress. Realised volatility is at historical lows and implied volatility is situated near the lower end of its annual range. Almost no one is buying hedges for the index.
It is a market that frustrates both bears and bulls: the former because it does not fall, and the latter because it does not move.
Bobby Molavi from Goldman Sachs Group commented that in recent months it has felt like "everyone is running at full speed to stay in the same place". Charlie McElligott from Nomura Holdings used the same imagery: equities "run to stay still" while "we fragment into a million small pieces".
The question is where all this running is leading.
The answer is rotation. Just look at the gap between the S&P 500 and its equal-weighted variant over three-month rolling periods to clearly see whether large-cap companies or the rest are leading. This year, the situation has oscillated: in May, large companies had a clear advantage; in August, they were at a disadvantage; and in September, they returned to lead.
In total, four complete cycles – of three or four months each – which represents the widest range recorded since 2022. The difference to the S&P 500 excluding AI tells the same story. The annual average hovers around zero. Neither consolidation nor market expansion has prevailed; the news lies in the oscillations themselves.
It is costly for anyone who must choose a side. Molavi from Goldman is frank about the situation: regardless of what a manager does with gross, net exposure or beta, the volatility of returns remains high and the outcome of the effort is scarce or negative.
Nick Savone from Morgan Stanley takes a different approach by contrasting the levels near all-time highs of the S&P 500 with the five consecutive weeks of declines in the Russell 2000. Moreover, he points out that more than half of the stocks in the Russell 3000 have suffered a drop of -20% or more since June. "Perhaps the big question is what will be needed for the market as a whole to get back in the game", he writes.
Data from the bank's prime brokerage division shows that last week, hedge funds reacted to market conditions by making the largest net sales of US stocks since July. They shed stocks related to AI infrastructure – such as those in the semiconductor and optical networking sectors – to buy, instead, shares of consumer staples, utilities, and real estate. After all this activity, US long-short strategy hedge funds recorded a decline of around -0.4% this month, compared to the +1.5% gain of the S&P 500 up to 8 October. Approximately 30% of these funds reported negative returns so far this year.
Why does none of this affect the index? McElligot from Nomura attributes the situation to the "volatility machine". Massive short-term option sales – much of it with daily expiry – leave intermediaries with a long gamma position; this leads them to sell during rises and buy during falls. Realised volatility decreases, allowing funds that manage target volatility, trend followers, and risk parity funds to increase their exposure, collectively bringing it back to levels close to the highs of the year. Lower realised volatility also encourages greater option selling.
The dispersion among S&P 500 stocks sits in the 79th percentile of the last five years. This shows that volatility exists, but it is concentrated in individual stocks and specific sectors rather than the overall index. The nearly -6% crash in Seoul falls into the realm of tail risks without shaking global benchmark indices.