Ben chabot
@chabot_ben
Professor at Northwestern University. Teach finance at UC-Booth. Former Economist and Senior Policy Advisor at Federal Reserve and Professor at UMich and Yale.
258 Following 4.7K Followers
Short interest on the median stock is approaching 2008 levels. Aggregate short interest has been a good predictor of the aggregate equity premium and the ratio of short interest to institutional longs did a good job of predicting individual stock returns for smaller stocks in the past. Other academics have found a robust relationship between high short interest and individual stock crash risk.
Just one more data point (like P/E ratios) in favor of the hypothesis that the expected return on stocks is low right now.
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BREAKING: Short interest in the median S&P 500 stock is up to 3.2% of market cap, the highest level since 2009.
This is now approaching the 2008 Financial Crisis peak of ~3.8%.
By comparison, during the 2022 bear market, this percentage was ~1.7%.
Furthermore, short interest among the most heavily shorted 10% of S&P 500 stocks is up to 8.0% of market cap, the highest in 8 years.
Even during the 2000 Dot-Com Bubble burst, short interest never surged to these levels.
The short trade is starting to look overcrowded.
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Stock market crash risk and volatility in general increases in September. This isn't just a statistical illusion. There's a large academic literature explaining why calendar effects increase fundamental news flow in September and how the looming end of the fiscal year changes the trading behavior of fund managers trying to lock in gains before bonus time.
I walk through the reasons in the blog post linked below, but in my opinion, one of the most eloquent explanations for the end of year risk-aversion was articulated by Billy Ray Valentine in his 1983 "G.I. Joe Kung-Fu Grip" theory of loss aversion...
Blog:
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Why does stock market crash risk increase in September and October?
Behavioral biases and tax and school calendars combine to make September and October a particularly risky time to hold stocks.
I outline the reasons in a new post on the blog:
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Is this 4-deminsional chess?...
Trump says cut rates --> fed raises rates instead--> enhances market belief in Fed independence --> bond market is relieved and lowers term premium and inflation expectations --> and Fed requires fewer rate hikes than they would otherwise need and financial conditions ease
Or
Blind rage at an independent agency?
it's a Rorschach Test!
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JUST IN: 🇺🇸 President Trump calls for the Federal Reserve to cut interest rates.
The S&P500 trailing 12-month P/E is above its historical 95% percentile. Do elevated valuations coincide with elevated crash risk? Yes!
Using Mishkin and White's (2002) definition of a "crash" as a 20% decline in the next month, quarter or year, crashes have occurred about 7% of the times that P/E has been this elevated over the past 100 years.
Elevated P/E has predictive power for crash risk. Does that mean an investor should get out of the market when P/E is this elevated? Not necessarily!
Even with the more frequent severe drawdowns, the equity premium has been so large that an investor who stayed in the market regardless of P/E earned higher returns than an investor who exited when P/E was this high. The false positives (high P/E but no crash) were frequent enough to outweigh the losses during a crash.
Those high returns come with more volatility, however, so the decision to stay in the market depends on the risk aversion of the investor.
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The SORF curve is now up 12-14 basis points for the Dec26-Dec27 contracts. The chair's speech moved the expected policy path up by half a rate hike.
The 10-year yield is holding up with its yield up only 5bps.
The Chair's speech pushed future markets toward more FOMC uncertainty (market probabilities are nearer to 50-50) which normally weighs on the long bond through the term premium, but the speech had lots of calming clarity about the commitment to the 2% target and the measure the Fed would use (still PCE) and no surprises about the balance sheet.
I think this clarity is helping the long end even as uncertainty about the path is increasing.
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What's driving the increase in bond yields?
A new post on the blog:
Neither the increase in issuance nor changes in uncertainty can explain the increase in bond yields over the past 8 week. Fear of future issuance and models of contagious runs do fit the data, however.
I talk about what these models predict can happen to bond yields and what datapoints I'm looking for from Jackson Hole and the economy.
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Market reads the Chair's speech as hawkish. Fed Fund futures odds of a September hike moved from 35% -> 57%.
More importantly the futures markets are now pricing in multiple hikes by year end. The futures implied probability of two or more rate hikes by year end increased from 29% -> 48%.
Remember these are odds implied by future market prices (CME FF tool). Because of risk aversion market implied odds of rate hikes are greater than the actual probability (explained in the blog linked in the tweet below). That said, the increase in these probabilities tell use investors have increased their likelihood of odds and/or are more worried about loses they will suffer should rates increase more than expected.
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The market is unusually uncertain about today's FOMC decision.
My thoughts about what derivative markets are telling us about the path of interest rates...
Market is relaxed and on vacation before Jackson Hole and the BLS revision. 1DTE SP500 25d risk-reversal is -2.1 which is the 29th percentile over the past year.
What's driving the increase in bond yields?
A new post on the blog:
Neither the increase in issuance nor changes in uncertainty can explain the increase in bond yields over the past 8 week. Fear of future issuance and models of contagious runs do fit the data, however.
I talk about what these models predict can happen to bond yields and what datapoints I'm looking for from Jackson Hole and the economy.
Show more
The difference between the implied vol on the ATM SPY options that exercise at 5:30pm tonight and the SP500 future options that exercise at 4pm today is now up 19.2 points.
Market expects a move in S&P 500 with the NVDA earnings.
Explained below...
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Nothing I post is ever investment advice...
NVDA releases earnings after the close (typically around 4:20ET) and option traders expect it to be a major market mover.
On the blog I explain how to use the quirk in exercise time between the S&P500 futures 0DTE options and the S&P500 ETF options to construct an option from 4-5:30PM today.
see:
The ES Futures options close and either exercise or expire automatically at exactly 4pm ET. But ETF options have an extended trading session until 4:15pm and can be exercised until the OCC deadline of 5:30pm ET (your broker will demand earlier instructions to have time to process).
The difference between the price of the SPY and ES options therefore tell us traders' expectations about the volatility from 4-5:30pm today.
The ATM SPY call IV is 6.5 pts above the ATM ES call. And the SPY put trades 7.1 IV points above the similar ES put. (these numbers tend to increase as we get closer to 4pm and the likelihood that the ATM strike now will be the ATM strike at 4pm increases)
Expect a market moving report from NVDA
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Nothing I post is ever investment advice...
NVDA releases earnings after the close (typically around 4:20ET) and option traders expect it to be a major market mover.
On the blog I explain how to use the quirk in exercise time between the S&P500 futures 0DTE options and the S&P500 ETF options to construct an option from 4-5:30PM today.
see:
The ES Futures options close and either exercise or expire automatically at exactly 4pm ET. But ETF options have an extended trading session until 4:15pm and can be exercised until the OCC deadline of 5:30pm ET (your broker will demand earlier instructions to have time to process).
The difference between the price of the SPY and ES options therefore tell us traders' expectations about the volatility from 4-5:30pm today.
The ATM SPY call IV is 6.5 pts above the ATM ES call. And the SPY put trades 7.1 IV points above the similar ES put. (these numbers tend to increase as we get closer to 4pm and the likelihood that the ATM strike now will be the ATM strike at 4pm increases)
Expect a market moving report from NVDA
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Core PCE was in line with expectations. The SOFR curve is essentially unchanged this morning.
The market is unusually uncertain about today's FOMC decision.
My thoughts about what derivative markets are telling us about the path of interest rates...
