Breadth of the US stock market (number of new highs minus number of new lows) is pointing to continued weakness in the markets.
Over the last five years, on average, the price of the S&P 500 index has been about 20% above its long term mean. This dynamic broke down in June-2015 and it coincided with a text-book-correction: dropped 20%, tested support and bounced off. Since then, however, it has struggled to go over 16% of its long term mean. The last two times it tried to get above 16% (Feb-2017) and (May-2017) it turned back down. The market has lost its upside momentum.
Every time the ratio of 1 month S&P 500 volatility to 3 month S&P 500 volatility spikes, it, almost always, is accompanied/followed by a decline in S&P 500. Why would this time be any different?
When an asset that has been appreciating for the last 8 years turns lower even by small amounts, the introduction of negative daily returns to its return distribution tends to increase the volatility of that asset by a meaningful amount. While we are long volatility we think a better trade structure might be to focus on acquiring long exposure to volatility of volatility of the US stock market. In our view, one of the best trades for the next 12 months is to be long Vega of Vega. We will continue to develop this idea and post our thoughts on an ongoing basis.
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