The S&P 500 index hit a new high for the 45th time this year, but there is a force betting on a sharp decline

Taking a snapshot of the U.S. financial market right now presents an extremely healthy picture: the stock market continues to set historic highs, corporate bond prices show no signs of concern, and commodities remain actively traded globally under the drive of optimistic economic sentiment. However, if a "director" focusing on the market delves deeper into the market, the outlook will quickly become blurry. In addition to all the external bullish sentiment, the trend of expanding volatility measurement indicators is equally important across almost all asset classes.

For example, in the sharp downturn of the market in August and September, when trading in stocks and bonds became unfavorable, Wall Street traders were caught off guard and rushed into the hedging market—driving the hedging costs and volatility measurement indicators to rise almost as fast as the market itself.

Now, amidst the repeated record highs of the U.S. stock market, this hedging frenzy is creating unusual contours on various assets. In one example, the volatility measurement indicators of the U.S. stock and bond markets have just limited the weekly gains of the stock and bond markets on a large scale twice this year. The rise has pushed the fear indicators of volatility in both markets to their highest levels in over 20 years—especially compared to other periods when the S&P 500 index set historic highs, indicating traders' relatively cautious stance on the upcoming stock and bond market trends, and prompting some traders to take hedging measures to deal with potential upcoming declines.

In summary, due to the upcoming U.S. presidential election next month, uncertainty in the Federal Reserve's policy trajectory due to economic data, and recent financial market traumas making traders more cautious, some investment institutions on Wall Street remain concerned about the future trends of the stock and bond markets.

Amy Wu Silverman, head of derivatives strategy at RBC Capital Markets, said, "It must be said that the probability of some low-probability, very bad events occurring is increasing." "After the VIX index surged violently in August due to the yen unwinding turmoil, the U.S. stock market has returned to normal and reached new highs. However, potential concerns still remain high."

While cross-asset prices, including stocks and bonds, often rise during recent investor anxiety, the current situation is particularly extreme, with bullish and bearish sentiments equally evident, each accounting for about 50%. The U.S. benchmark index—the S&P 500 index—has risen for five consecutive weeks, ending the past eight weeks with weekly gains, especially as JPMorgan Chase and Wells Fargo kicked off a new round of U.S. earnings season, and their performance exceeded market expectations. The S&P 500 index closed at its 45th historic high of the year on Friday, reaching an intraday high of 5822.13. In the bond market, the U.S. investment-grade bond spread has hit its smallest level in over three years.

Rare Trend: VIX Index Rises During US Stock Bull Market

However, due to the lingering shadow of the global financial market crash in early August and September, indicators measuring investors' anxiety levels are showing cautious readings, which is very rare during a stock market bull market period.

Statistical data shows that since the beginning of this month, both the stock market panic indicator - the Chicago Board Options Exchange Volatility Index (VIX) and the US bond market panic indicator - the ICE BofA MOVE Index have risen significantly. The global cross-asset risk index compiled by Bank of America Corp. has reached its second-highest level of the year, second only to the scale of the market sell-off in early August, which wiped out tens of trillions of dollars in global stock value in a matter of days. This index tracks the pressure in global stock, interest rate, currency, and commodity markets, and measures the implied future price volatility of options.

In other words, although the US stock and bond markets are currently calm, the past shock effects and uncertain future prospects are seriously affecting investors' sentiments, and there is already a pool of funds preparing for a decline in the US stock market.

Traders who were shocked by the summer chaos are dealing with the deadlock in the US presidential election, regional conflicts in the Middle East, and the still-expanding US economy. However, whether the US economy can successfully achieve a "soft landing" continues to raise market doubts, such as this week's jobless claims data being higher than expected for the first time in weeks.

Meanwhile, more and more investors believe that the Federal Reserve led by Chairman Powell may not be inclined to immediately inject new vitality into the US economy. Data released on Thursday showed that consumer inflation was higher than expected, and last week's US employment report surged, leading traders to reduce their bets on a 50 basis point rate cut in 2024. Raphael Bostic, the Atlanta Fed President who has FOMC voting rights this year, even said he would be willing to skip another rate cut next month.

"There is almost a sense of distrust in the market," said Peter Tchir, head of macro strategy at Academy Securities. "There have been some big moves overnight. Investors do have a lot of concerns, but the stock market is generally on an upward trend. We have also experienced several rapid declines during this period."

"Air Force" Bears Ready to Strike Back

After investors drove a synchronized rise for five consecutive months, there are clear signs of the "air force" bears, or short interest positions in bonds and stocks, rebuilding. According to IHS Markit data, bets against the SPDR S&P 500 ETF Trust (SPDR S&P 500 ETF), also known as the S&P 500 ETF, have reached 2.4% of its outstanding shares, higher than the four-year low of 1.6% at the beginning of this month. Similarly, the short interest ratio of the iShares 20+ Year Treasury Bond ETF hit a new low in 15 months in August, but has now risen to over 1%.

Option market statistics show that as the US stock bull market continues, investors' demand for hedging protection against a major US stock market decline is growing stronger, reaching rare levels of tail risk hedging measures in the past two years The MOVE index, which tracks bond market volatility, has surged to its highest level since January, while a similar indicator in the oil market has soared to a level not seen in two years. Since August, the implied volatility of the iShares iBoxx Investment Grade Corporate Bond ETF has risen relative to actual price movements, the latest sign that traders are buying insurance against losses.

Over the past month, the yield on the 10-year U.S. Treasury has risen by more than 40 basis points, while the S&P 500 index has risen by about 3% despite the upward pressure on U.S. bond yields. This is an unprecedented rebound since April 2022 - when the 10-year U.S. Treasury yield and U.S. stocks move in the same direction, typically U.S. stocks rise while U.S. bond yields fall or move sideways.

Erika Maasmeier, portfolio manager at Columbia Threadneedle Investments, said, "Despite some macro and micro risks, the market has been very strong." "As we approach the peak of the election and the next Fed rate decision, we wouldn't be surprised to see a pullback."

In addition to the U.S. election and Fed monetary policy, the earnings season is also the next major test facing the market, with the overall P/E ratio of the S&P 500 index reaching its highest level since 2021. While Wall Street analysts expect overall profits to grow by 4% in the third quarter, the slowest growth in a year, investors are still very focused on earnings reports, especially those of the seven major tech giants in the U.S. with high weights in the S&P 500 index. Data compiled by Bloomberg Intelligence shows that Wall Street analysts generally expect the overall profit growth of S&P 500 component companies to accelerate next year, potentially reaching 14%.

"Investors are showing extreme optimism, even though valuations are very high," said Michael O'Rourke, chief market strategist at JonesTrading. "Strong economic data, coupled with the Fed FOMC's aggressive easing stance last month, have fueled investors' overconfidence."