Back on July 7th we wrote an article about the massive spread between Nasdaq & S&P500 volatility – a spread that signified risk for the Nasdaq due to massive tech gains into July.
We had two conclusions from that article. The first was that near-term correction was due as the massive SPX/NDX volatility spread signaled unstable options positioning:
From the publishing of that article, the Nasdaq fell more that 8%, while interestingly the S&P500 had a much more benign 3% correction.
More importantly, the “re-syncing” that we called for has largely come to pass as NDX volatility has declined sharply despite the downside price action. Here we have the VXN (Nasdaq Volatility Index) vs the VIX (S&P500 Volatility Index), and you can see the spread between the two has returned to a long term mean. With the spread normalized, the NDX/SPX relationship is back on stable footing – which means the structural differences between the two indices, rather than positioning stress, are now what drive relative performance.
The second, longer term conclusion from that article was that the Nasdaq was likely to continue to have a new, higher level of volatility than the S&P500 do to the importance of the AI. We argued that while generally investors associate volatility with risk, volatility can also be welcomed if its associated with upside price action.
This second argument has now hit a critical crossroads.
As more economic growth is driven by growth in AI, the Nasdaq could continue to see faster price appreciation vs other major US indicies. Further, as we discussed in our original article, the changing of the Nasdaq methodology in June allowed for fast-tracking major new listings such as Anthropic, which is set to IPO in November.
S&P500’s Negative Beta
Over the last several weeks, the S&P500 has seen a massive increase in negative-beta amongst its constituents. In fact, 119 components of the S&P have price action that moves inversely to the Index itself. You can see the increase in these components in black, below, which now account for 24% of the S&P500’s weight (based on a 3-month price window).
Also plotted is the US10 year rate (orange), which is simultaneously making new highs. It is this rate issue, being driven in large part by oil, that is driving the negative beta phenomenon.
Because of higher rates and higher oil prices, sectors like energy, insurance and utilities are have been moving higher in tandem with oil/rates. However, when oil/rates go higher, that tends to send the S&P500 lower.
The result of this diversification has allowed the S&P500 to outperform the Nasdaq by 1.5% since our July 7th note. This outperformance was because as oil/rates went higher, sectors like energy outperformed. The Nasdaq 100 contains just 2 energy names: BKR & FANG.
This energy factor has therefore helped the S&P500 relatively to the Nasdaq as oil prices rose sharply. Through this lens, diversification has helped the S&P500.
That was diversification working in the S&P500’s favor. The problem is what happens when the tape flips: over the last several sessions oil prices have slid from $105 to $95 (bottom pane). Over that same period, the Nasdaq outperformed the S&P by 1.5%.
This highlights the diversification problem: if oil & rates move lower then large components of the S&P500 may slide lower, which is a tax on Index performance. Meanwhile, the technology index has much less of a oil/rate tax – and has adjusted constituency to concentrate in the leading sector for economic growth, which may give it significantly more torque in future bull markets.
The Price of Volatility
Nasdaq volatility is increasingly expressing itself to the upside. NDX remains structurally more volatile than SPX, but over the trailing year its upside realized volatility has exceeded its downside realized volatility by roughly 10%, an asymmetry stronger than we’re seeing in SPX.
Our data shows that, in absolute terms, NDX’s current up-day realized vol is ~66% higher than S&P. We suspect this spread may only increase if oil and/or rates drop, and as we near the Anthropic IPO.
Meanwhile, both the S&P500 and Nasdaq have currently reached 1-year lows in realized volatility (blue). Accordingly, 1-month implied volatility i also back near 1-year lows – signaling that options may be cheaper than they’ve been vs any point in the prior year. This, despite the Midterm catalysts and additional volatility added due to the Iran war.
Further, ahead of the key Midterms catalyst in November, we see that NDX (QQQ as a proxy) November call skew is also near 1-year lows – a signal that upside calls are relatively cheap. While it is true that the S&P500 shows a similarly low implied volatility, we argue that if equities resume their bullish trend, the Nasdaq is more likely to express that upside through higher volatility – which benefits long call positions.
That is the diversification problem in a nutshell: the S&P500 now carries a large block of components that fight the tape, while the Nasdaq has concentrated itself in the market’s leading growth engine just as its upside volatility has gone on sale – and with the Anthropic IPO still ahead in November.