U.S. stocks took the stairs during the six-month slog back from February’s market correction. Signs are mounting that investors expect them to ride the elevator even higher.
The S&P 500 Index has rallied 3 percent in the past two weeks alone, ending at an all-time high and popping above 2,900 for the first time. The surge has taken it within a whisker of overbought territory -- harking back to January when market euphoria pushed global equities into technically stretched waters, and then a violent correction.
Market strategists don’t expect a repeat. Wall Street’s biggest cohort of bulls has ratcheted up estimates for where stocks end the year, with Barclays and Weeden & Co. now expecting the S&P 500 to hit 3,000 -- 3.5 percent higher than Tuesday’s close. That’d give the equity benchmark a 12 percent gain for the year.
The buy-side might play a major role in those predictions coming true.
The correlation between the S&P 500 and an index of hedge funds is near its weakest in the past five years, a sign that buy-side investors might feel pressure to boost their exposure to risk assets to avoid being left further behind.
Melt-Up, Redux
The ratio of bearish option bets to bullish ones is waning as the S&P 500 keeps churning out records. That implies investors may be loading up on derivatives as way to make up for lost ground should 2018 deliver a year-end rally similar to last year’s, when stocks closed with a 6.1 percent fourth-quarter surge.
And the dynamic playing out in the options market might just be getting started.
“Melt-up protection, that tends to happen really when you start to see new highs in the S&P,” said Maneesh Deshpande, head of U.S. equity and global derivatives strategy at Barclays. “Now we’re just getting there, so in my opinion I think the next few weeks are going to be key as we break out, that’s when you start to see a scramble.”
Buoyant appetite for call options may offer one explanation for why the Cboe Volatility Index, also known as the VIX or Wall Street’s fear gauge, rose in tandem with equities in recent sessions. A similar situation preceded the record spike in volatility earlier this year that abruptly ended the previous stretch of all-time highs for U.S. stocks. However, key differences suggest a precise repeat of that episode isn’t in the offing.
Positive Positioning
Other asset classes show speculators think markets will keep dancing to the risk-on beat. The weekly commitment of traders report points to significant bets that U.S. implied equity volatility and gold -- which tend to rise in periods of stress -- will fall, and that Treasury yields will rise.