I’m undertaking a 1000-day reinvention project, blogging here daily to track my progress. In Thursday Thinker, I share a smart idea or theory.
From MarketWatch, AI stocks are echoing a 1990s market split:
JPMorgan strategist Jason Hunter suggests that the divergence between semiconductor equity performance and that of hyperscalers, where “AI spenders are punished and AI-spending recipients are rewarded” is concerning:
If hyperscalers struggle to get past important technical resistance levels “and come under renewed pressure for whatever reason over the near-term, while the semiconductor group is still trading below its key resistance, what started as a rotation within the AI-theme could feed into a more concerning unwind,” he told clients on Wednesday.
Lately, it’s been a stock pickers’ market, as certain names do well and others lag. Correlation across S&P 500 stock performance has fallen close to a record low.
Implied correlation estimates how much individual stocks in an index, such as the S&P 500, are expected to move together in the future. Right now, we also are seeing elevated dispersion levels — the difference between the implied volatility of the index itself and the average implied volatility of its individual components.
I’ve seen in my recent options trading that index volatility is very low, while certain stocks have high IV.
One Twitter observer says that traders may benefit from this situation, while buy-and-hold investors suffer, but it also could indicate rough seas ahead.
I suspect this will continue for the foreseeable future. While it can make for a trader’s paradise, it can have negative implications for “buy and hold” portfolios that are oblivious to movements in individual stocks not trading inline with headline indices.
Lastly, high dispersion and low implied correlations tend to occur near market turns, as we saw in 2000. While this doesn’t mean markets will roll over immediately, those paying attention to these critical factors can save themselves a lot of heartache. Hence why, and especially now, proper risk management is key!
Michael Cembalest of JPMorgan Asset Management says that in the later stages of the dotcom boom, you saw divergences in index components and sectors marking the top:
“So you had this period in the market where the front end, which were the communications-services stocks, started to flatline, but the infrastructure stocks kept going, and it was a bit of a head fake to the market,” Cembalest said.
Currently, stocks of hyperscalers at the front end of the AI boom are stagnating with falls in free cash flow, while chips, infrastructure providers and optical networking gain. “There are some parallels here that I think we need to think about because you always want the caboose going fast, slower than the front of the engine, and that’s not what’s happening,” he said.
But lately, semiconductors have dropped while hyperscalers bounced back a bit. In a truly bullish market, you’d want to see everything advancing at once.
My recent moves
I closed out a short put on $SMH (a semiconductor ETF) as semis bounced to decrease my exposure to that sector. I have exposure to the hyperscalers, but not too much, and at pretty low deltas and strike prices.
My two energy short puts closed yesterday and I didn’t choose to add on more. I expect a Trump TACO shortly, as oil prices soar after the Houthis claim they struck Saudi Arabian tankers in the Red Sea, after announcing a blockade earlier this week.
Because implied volatility of energy equities and ETFs such as $XOM, $CVX, $XLE, and $XOP should be up today it would be alright to sell puts, even at risk that oil comes back down a bit with an expected TACO.
The strategy here, for an options wheel trader such as myself, would be to identify the high volatility equities that still show good strength, and focus on those.