Q2 saw US equities in rally mode all three months, with smaller gains of 1.6% and 0.5% in April and May followed by a large 6.48% gain in June. It was the biggest quarterly gain for equities since Q4 of ’21, and left the S&P 500 total return index about 6% below its all time highs.
But unlike those big post Covid rallies which were littered with sharp reversals lower and high volatility – the Q4 up move had little to no downside volatility to deal with. The quarterly return was never down more than -1.2%, resulting in the VIX only ticking above 20 on two occasions during the quarter (barely… at 20.09 and 20.03).
As mentioned in our April commentary, this quietness led to the elimination of the VIX ‘floor’ that has been in place since the beginning of 2022, and really since the onset of Covid in March of 2020. This was the first quarter since Covid the VIX remained meaningfully in the teens, with June seeing a new post-Covid low in the VIX at 12.91.
At just 6% or so away, it seems like we’re too close now not to rally back and set new all-time highs in the stock market, which should keep volatility subdued a bit longer. But after that? Who knows. There’s plenty of literature out there on new highs begetting more new highs and the start of a new bull market, but there’s still a Fed hellbent on taming inflation and this recession everyone keeps predicting but hasn’t quite shown up yet.
Two big question marks are getting our attention, however. One, the increasing concentration in equity market returns, where nearly all the recent market gains have come from just a handful of companies. Is that sustainable? Does that add the possibility of increased volatility as the market becomes more and more reactive to those company’s every move?
Secondly, the amount of short volatility needing to be covered (essentially by selling stock or buying options) across options, vix ETFs, and more is at its highest level since early 2018. Pairing that with a VIX touching 12 is like winding up a jack in the box. Eventually all that pent up and suppressed volatility will pop out. When and where and by how much are the billion dollar questions.