S&P 500 Dispersion Signals Potential Market Pullback
Stocks finished the day mostly lower, though not by much—especially considering last week’s move, as the S&P 500 dispersion trade continued to play a role in the price action. Essentially, we traded inside Friday’s range and consolidated sideways. There is a sizable gap of around 7,040, and it would not be surprising to see it filled, as that has generally been the pattern since around October. A move to close that gap would not surprise me at all.
Additionally, the spread between the S&P 500 dispersion index and the 3-month implied correlation index has been trending lower over several days, with the S&P 500 moving in line with that spread. If that spread declines again tomorrow, it would further support a move lower in the index.
We are now entering a phase in the cycle where dispersion typically stabilizes before beginning to unwind as companies report earnings. By next week—especially after the bulk of mega-cap results—the unwinding process of the dispersion trade is likely to begin. (Learn more here: How the Volatility Dispersion Trade Moves the Stock Market)
Brent crude moved back above $94, a level that continues to act as important support despite closing below it on Friday. From a technical perspective, the chart appears to be forming a falling wedge pattern. Price is supported by the 50-day moving average below, while resistance sits just above current levels at the 10- and 20-day exponential moving averages.
A breakout above those moving averages, particularly if accompanied by strengthening momentum, could push oil back toward the highs near $110. Conversely, a break below support around $94 would be bearish and likely result in a move back into the low $80s.
Oil remains a critical factor in determining market direction, given its broader economic importance and its impact across asset classes.
It is worth keeping an eye on the 10-year Italian-German spread, as it provides a straightforward way to track whether credit spreads are widening or tightening. Today, the spread rose to 75 basis points, which remains historically tight. More importantly, the spread appears to be attempting to trend higher, with the relative strength index indicating that momentum has turned upward.
We will see how it develops, but this is something worth watching closely.
-Mike
Glossary by ChatGPT
Basis Point: One hundredth of a percentage point (0.01%), commonly used to describe changes in yields or spreads.
Correlation Index: A measure of how closely individual stocks within an index move together.
Credit Spread: The yield difference between two bonds of similar maturity but different credit quality or issuers.
Dispersion: The degree to which individual stock returns within an index diverge from one another.
Exponential Moving Average (EMA): A type of moving average that gives more weight to recent price data.
Falling Wedge Pattern: A technical chart formation characterized by converging downward-sloping trendlines, often signaling a potential breakout.
Gap: A price level on a chart where no trading occurred between two sessions, often revisited later.
Implied Correlation: The market’s expectation of how correlated index components will be, derived from options pricing.
Relative Strength Index (RSI): A momentum oscillator that measures the speed and magnitude of recent price changes.
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