Extremes, extremes everywhere

Happy Sunday! We're dealing with a market where we're seeing some signs of potential exhaustion. Let's take a look at what's going on underneath the surface.

VIX: S&P 500 implied volatility last read 29.92, vs 1-month realized at 25.57, suggesting volatility is getting expensive again. There was a fair amount of index put buying as we saw the index put/call ratio rise to 1.43 and the ETF put/call ratio to 1.67. The top of the list, though, was SPX + SPXW put/call ratio at 1.71. All suggesting some level of institutional hedging is on the rise.

HY spread: We saw some widening last week, but not commensurate with a level that would suggest the level of risk to shorter maturity junk debt is fully appreciated by the market, given that we're in a macro backdrop with meaningfully tightening financial conditions set to come, on top of a recessionary economic environment. A combination that is likely to be problematic for lower rated borrowers being able to sustain their debt loads or refinance.

NYMO (inverted): The NYSE McClellan Oscillator printed the most negative exhaustive reading (-116.38) that we've seen since the COVID crash, an extreme that strongly suggests seller exhaustion may be at hand. Often when we see prints this extreme we do see some level of mean reversion within the S&P 500, such as a 50% retracement. Whether this time proves to be different remains a key question. These conditions can worsen before they get better and they can persist for some time as well (as we saw in 2020).

CBOE equity put call ratio: The most bearish reading we've seen since the COVID crash at 1.02 just registered on Friday. Retail was piling into puts to end the week in a big way! These sorts of extremes can potentially be contrarian indicators, especially once they reverse and we see that 'peak fear' has been achieved and we begin to see constructive call buying flows exceed the demand for puts by a reasonable margin (0.65 or lower).

NAAIM (inverted): Positioning became more bearish last week, but not near the extremes during the COVID crash, or even what we saw earlier this year. What we do know is managed money sold the dip once again. They've often been on the wrong side of the trade this year.

Rydex bear/bull ratio: More and more demand for bearish positioning suggests that retail is becoming more concerned, and expressing that concern with insurance against downside or even directional bets through these funds.

We saw the most extreme new lows vs high highs on the New York Stock Exchange in 2022, at a delta of 1098. That's a reading that does suggest exhaustion is possible, and certainly a reading that's worth watching closely. The last time we were close to this level was June, during what later turned out to be pivotal lows.

Investors Intelligence shows bull vs bear sentiment once again reaching an extreme that is near levels where prior lows have been carved out in the market.

There's a similar picture with the nosier AAII Sentiment survey, which shows retail investors are the most bearish they've been since Q1.

Citigroup's Economic Surprise Index suggests that the S&P 500 may have some room to rise here off the lows if the prior correlation holds. The current divergence is rather large.

The flight to safety in the form of institutional rotation from high beta (riskier) stocks to low volatility (more defensive) stocks is reaching levels we haven't seen since July. Another sign of angst being a prevalent theme not just in sentiment, but also positioning.

The big caveat to all of this is that we are not in a well hedged market. Skew, while rising at a healthy clip on Friday, is not at a level where we could suggest that market participants are properly prepared for further downside risk.

Thus, if there is a powerful negative event volatility catalyst, it's fair to say that left tails are likely to be fatter, with larger price potential to the downside in a shorter period of time.

That all being said, we have some degree of right tail potential back on the table given how stretched sentiment, positioning, breadth, and market conditions overall have become to the bearish side.

The two most likely scenarios at this point are either:

Be nimble! I am using smaller position sizes and shorter time frames for a lot of my trades.