Interview
Equity Volumes, Volatility and ‘Skew’ in the Markets
- Retail investors drove significant market activity, leading to large-scale short covering in single-name stocks and a subsequent rotation into ETF shorts.
- ETF shorts now constitute over 20% of the firm's short book, marking a record-high level.
- Market volumes are at record levels for the year; seven of the ten largest trading days in history occurred in January 2021, despite it being a short calendar month.
- Small order size trades, driven by retail inflows, now represent 25% of total market volume, a sharp increase from approximately 10% in 2019.
- Current market dynamics are characterized by a supply-demand imbalance, with a historical lag in volatility sellers returning to the US index space since March 2020.
- Institutional demand for downside protection is high, while retail demand for upside exposure is surging, keeping implied-to-realized volatility spreads in the S&P wider than usual.
- Market participants expect a regime shift toward lower index volatility driven primarily by increased sector dispersion rather than market normalization.
- A historical divergence in market skew is observed: index skew is trading very high due to institutional hedging, while single-stock skew is trading flat due to retail dominance.
- Retail option activity is predominantly short-dated, with the majority of trades involving one-to-two-week expirations rather than long-term horizons.
- Market intermediation for these retail flows is primarily handled by market makers rather than larger banks or institutional players.
- The fiscal stimulus package currently in reconciliation could exceed the anticipated $1 trillion, potentially expanding beyond President Biden's initial proposal.
- While larger fiscal stimulus is viewed as positive for equity growth, a significant risk exists if rising nominal yields outpace growth expectations.
- A primary market risk involves runaway wage growth potentially eroding corporate profitability if inflation outpaces economic expansion.
- The Federal Reserve's "average inflation target" framework is viewed as pro-cyclical, potentially supporting equities if the Fed holds rates anchored despite rising inflation.
- Base effects from mid-year comparisons and "revenge spending" following pandemic restrictions are cited as potential catalysts for higher inflation.