One of the oldest — and truest — market axioms is that in a crisis, correlations go to one.
That means when conditions take a meaningful turn for the worse, everything in the stock market goes down together.
Right now, we’re in the midst of one of the longer streaks in history without a 2% decline for the S&P 500: 321 sessions and counting. Amid this streak, the VIX Index — a gauge of the how volatile the S&P 500 is expected to be over the next month — recently hit its lowest levels since 2019.
Meanwhile, these days tech stocks are still doing relatively well when bond yields are rising — because no matter whether the risk-free rate is 4% or 5%, that’s a rounding error compared to the return potential associated with AI, in the minds of corporate executives. That kind of spending does not appear to be that rate-sensitive — especially because the companies with some of the biggest AI capex outlays are sitting on piles of cash in the form of retained earnings.
Back in 2017, the narrative was more about high yields being a headwind for expensively-valued tech stocks, because so much of their earnings potential was in the future not the present (and would need to be discounted by this higher interest rate).
Another key way in which this story only rhymes with but doesn’t quite match the excruciatingly low-volatility world of 2017 is that these individual groups are, on their own, moving much much more. Their moves are just offsetting one another.
“The difference between now and 2017 is when bond yields were so much lower we didn’t even have these under surface swings like we do now,” said Dave Roberts, independent trader. “Indexes are fine now, but names and sectors are still moving a lot more than 2017.”
It’s like a duck: the illusion of calm on the surface of the water belies the furious paddling going on underneath.
The KBW Bank Index and the Invesco QQQ Trust Series 1 ETF (which tracks the Nasdaq 100) have had a daily gain or loss in excess of 1% on 74 occasions so far this year. Compare that to 88 instances for 2017 as a whole.
Putting this together, this suggests that if indeed we do get more of a “correlations to one” moment for the equity market, it could be quite a bit more disruptive than the down days were in 2017 — as the likes of tech and banks have already demonstrated they’re primed to move.
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