Stocks Hold Near Highs as Liquidity Remains Constrained and Volatility Suppressed

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Market Narrative

The S&P 500 rose by approximately 65 basis points on Friday, a move that was largely driven by implied volatility declining following the jobs report, rather than a broad-based shift toward risk-taking.

Overall market action continues to reflect sideways, choppy trading conditions, similar to what was observed at the end of last year and during much of 2018 and 2019, when liquidity was gradually leaving the system. Despite the S&P 500 trading near all-time highs, gains over the past couple of months have been modest, while the Nasdaq remains below its late-October levels.

Liquidity conditions remain a key constraint, as recent stabilization has occurred at relatively low levels, and upcoming Treasury bill issuance is likely to begin drawing liquidity out of the system again, potentially pressuring funding markets such as SOFR.

As earnings season approaches, dispersion trades are re-emerging, with constituent volatility rising and index volatility remaining suppressed, a dynamic that often limits sustained index advances. With implied correlations already at historically low levels and volatility near the bottom of its range, current conditions suggest continued choppy trading, with markets remaining sensitive to any unexpected shocks unless liquidity and volatility dynamics materially improve.

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Fully Edited Transcript by ChatGPT

The S&P 500 rose by about 65 basis points on Friday. Most of that move was driven by implied volatility coming down after the jobs report, which had previously pushed implied volatility higher. In addition, uncertainty around the Supreme Court decision regarding Trump tariffs led to hedging activity that was later unwound. As a result, part of the market’s advance was more related to positioning and hedging dynamics than to a true risk-on rally.

When looking at overall market behavior, there has been very little directional movement. The market continues to trade sideways, similar to conditions at the end of last year, when liquidity was coming out of the system. At that time, the expectation was for either a market move lower or an extended period of choppy, sideways trading, similar to what occurred during much of 2018 and 2019. So far, that scenario appears to be playing out.

While the market is at all-time highs, gains over the past couple of months have been limited to roughly 1%, which is less than many expected. The Nasdaq, in particular, is lower than it was at the end of October and has done very little over that period. Liquidity remains a primary factor, having declined as expected and now stabilizing at low levels. Even with ongoing Federal Reserve operations, liquidity does not appear sufficient to materially change conditions in the near term.

This week, net Treasury issuance is expected to resume, reversing the recent period when Treasury bill paydowns were adding liquidity to the market. As issuance increases, the Treasury General Account could rise again, and SOFR may begin to move higher. While conditions may not become as tight as before, underlying liquidity issues have not fully resolved. These dynamics likely contribute to the ongoing choppy market action and may also explain why Bitcoin has remained depressed for several months.

Earnings season is approaching, which is an important period not only for company fundamentals but also for volatility dynamics. This is typically a period of volatility dispersion, where investors go long individual stock volatility while remaining short index volatility. This dynamic is reflected in the VIXEQ relative to the VIX, which have begun to separate again, similar to patterns seen from late September into mid-October. Historically, this trade unwinds once large-cap companies report earnings, as occurred in late October and early November.

Currently, constituent volatility is rising while index volatility remains suppressed, which tends to keep equity indexes elevated. However, implied correlation levels are already very low. Historically, such low correlation levels have coincided with notable market events, as seen in July 2023, July 2024, January 2025, and October 2025. Low implied correlations indicate that stocks are moving independently rather than in unison.

This environment helps explain the divergence between equal-weighted indexes and capitalization-weighted indexes, with the equal-weighted S&P 500 outperforming and the ratio of SPY to RSP showing signs of breaking down. This dispersion-driven trade typically lasts about a month and is already at a stretched point. Implied volatility is also at the low end of its range, suggesting continued choppy conditions rather than a sustained breakout.

The Nasdaq remains stuck near its 78.6% retracement level and faces potential resistance near 15,970, where a gap was created in November. Nvidia has also remained range-bound since August, reinforcing the view that broader market performance remains closely tied to its behavior. The technology sector, as represented by XLK, continues to consolidate in a sideways pattern, suggesting an ongoing consolidation phase rather than a clear directional move.

From a broader perspective, liquidity remains constrained, volatility is suppressed, correlations are low, and dispersion is elevated. While breakouts are possible, timing remains uncertain. Interest rates are also grinding higher, with the 10-year yield pushing against the 4.20% level and the 30-year yield breaking above a key resistance area. Bond volatility is extremely low, with measures such as VXTLT at levels not seen since January 2020, indicating complacency across asset classes.

Overall, low volatility in both equities and bonds suggests the market may be vulnerable to unexpected shocks. While this does not imply an imminent event, it highlights the importance of risk management and protection during periods of complacency.

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Defined Terms and Jargon by ChatGPT

• Implied Volatility: The market’s expectation of future price movement, derived from option prices.

• Basis Point: One-hundredth of a percentage point, or 0.01%.

• Liquidity: The availability of money or credit in the financial system that supports trading and investment.

• SOFR (Secured Overnight Financing Rate): A benchmark interest rate reflecting the cost of overnight borrowing collateralized by U.S. Treasury securities.

• Treasury General Account (TGA): The U.S. Treasury’s account at the Federal Reserve, which affects system liquidity as balances rise or fall.

• Volatility Dispersion: A trading environment where individual stock volatility rises relative to overall index volatility.

• Implied Correlation: A measure of how closely stocks within an index are expected to move together.

• Retracement Level: A technical level indicating how much of a prior move has been reversed.

• Range-Bound: A market condition where prices move sideways between defined levels rather than trending.

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Disclaimer

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