There is the temptation to measure the market temperature with our intuition. "This market feels like it's about to correct". There is also the temptation to completely silence the voice of intuition and only look at data sets (and derivations of data) with pre-determined recipes aimed at extracting signal without bias.
I believe both extremes are impossible to attain and are both wrong. Therefore, I will rely on data, layer on a modicum of intuition, and keep in mind always that the exercise is one of diagnosis, not prognosis.
Where are we?
Here are some indicators that can be useful for orientation. Nothing complicated, no VIX of VIX or third and fourth derivatives.
| Factor | Current | 10-year median | Direction |
|---|---|---|---|
| VIX | 19.44 | ~16.5 | ↑ |
| SKEW | 143.08 | ~138 | ↑ |
| Fwd P/E (SPX) | 21.1× | 19.9× | → |
| HY OAS | 276 bps | 400 bps | ↓ |
| IG OAS | 74 bps | 115 bps | ↓ |
| 10Y UST | 4.47% | 2.7% | → |
| Case-Shiller YoY | +0.7% | +2.7% | → |
The current levels are as of mid-June, and the direction arrows express the recent trend (approximately last 30 days).
My read of the current situation is that of a market that is starting to turn less calm. The volatility complex, both in VIX and SKEW, has started to inch up, which indicates tail-hedging demand. Credit remains very complacent in IG and HY, although spreads may look tighter due to the higher overall level of treasury rates (which satisfy all-in yield chasers such insurance, pensions, or foreign investors).
In Treasury land, a persistent ~4.5% 10-year UST has to act as a constraint on main street, particularly for home mortgages, which can be seen in the Case-Shiller YoY index. Roughly a quarter of U.S. household wealth sits in home equity, which at 0.7% YoY growth against 2-3% CPI means real home prices are going negative.
What else is going on?
Capital flows. There will be a good amount of capital rotation in the short term with equity offerings from Google ($85B), the SpaceX IPO, and the upcoming IPOs of Anthropic and OpenAI.
Tech concentration with 10 companies representing 40% of the S&P500. SpaceX, Anthropic, and OpenAI will make this phenomenon even more pronounced.
The war-oil-inflation dynamic. Brent crude at $85 has come down from the $100s, a level that persisted since March. If geopolitical risk subsides and oil declines further to the mid $60s (stable level before the US-Iran war), then the inflationary pressure will moderate.
What to watch and portfolio positioning
We will maintain a watchful eye on equity volatility and credit spreads. Complacency in credit markets may be dampening otherwise violent moves in other markets. A trend towards 300 in HY OAS with VIX holding above 18 would be a stronger signal of a regime change.
The market also has to experience significant rotation to fund large equity issuances in the coming weeks. SpaceX, Anthropic, OpenAI, Google. This is another element to follow closely.
All in all, the current regime is rich/complacent and, from here, the portfolio allocation follows:
- Floor: 50-55%
- Value: 35%
- Convex: 10-15%
Tail-hedging is starting to price up, and a careful allocation is in order (i.e., do not overpay) at a moment in which elements of a regime change are more than glimpses.
Conversely, if we see HY tightening through 250, VIX below 14, and a re-acceleration of Case-Shiller, then the party continues.