Domestic stock indices have rebounded from pandemic-induced lows exhibited in the spring of 2020 with relative ease, and U.S. equity market volatility has remained largely muted since that time as a result. The CBOE Volatility Index (“VIX”), a popular measure of expected volatility in the S&P 500, ended August at a level of 16.6, below the index’s 30-year average of 19.5. Based solely on recent performance and volatility levels of broad-based indices, the investor outlook for U.S. stocks going forward appears mostly positive. That said, other gauges of sentiment may indicate more discord among market participants. The CBOE SKEW Index (“SKEW”) is one such barometer. Unlike the VIX, which uses at-the-money S&P 500 Index options to assess expectations of near-term market fluctuations, the SKEW examines the implied volatility of out-of-the-money options to gauge perceived U.S. equity market tail-risk, or the chances of an extreme price change in the index. The SKEW Index ended August at a level of 155.9 after reaching an all-time high of 170.6 in late June of this year — both figures are well above the 30-year average for the index of 120.5. The recent upward movement in the SKEW indicates that investors have grown increasingly wary of an outsized move in domestic equity indices in the last several months.

It is important to note that an elevated SKEW Index is not necessarily a harbinger of a tail-risk event. Since 1990, the average 30-day return for the S&P 500 Index subsequent to the SKEW spiking into the 90th percentile of its history was roughly 0.9%. The inverse is also true — extreme S&P 500 returns are not always precipitated by an elevated SKEW Index. In the two years leading up to the Tech Bubble Crash and Global Financial Crisis, the SKEW averaged levels of 115.4 and 116.6, respectively, both of which are below the long-term mean for the index. All of that said, there are obvious risks currently facing markets that could lead to pullbacks and may be contributing to heightened SKEW measures. For instance, valuations of most U.S. equity indices remain elevated relative to historical norms and heightened inflation could ultimately prove less transient than currently expected by market participants. Additionally, the S&P 500 Index has experienced a maximum drawdown of just 4.1% so far this year, well below the median annual drawdown for the benchmark of 9.7% going back 30 years. While this data point alone does not portend a correction, a near-term drawdown is certainly possible given the myriad factors at play. In light of the current landscape, we believe it is imperative for investors to remain diversified across the asset class spectrum in order to gain exposure to a potential continuation of recent positive equity performance while also helping to protect portfolios in the event of a correction.

Print PDF > The Turn of the SKEW

The opinions expressed herein are those of Marquette Associates, Inc. (“Marquette”), and are subject to change without notice. This material is not financial advice or an offer to purchase or sell any product. Marquette reserves the right to modify its current investment strategies and techniques based on changing market dynamics or client needs.

S&P 500 earnings growth of nearly 30% year-to-date has completely eclipsed that of the last 10 years. This is in stark contrast to the previous two years, when 18% and 31% market gains were almost entirely driven by multiple expansion. The 2021 rebound in earnings follows last year’s sharp COVID-induced decline and has some investors wondering what an almost inevitable slowdown from here could mean.

As of the end of June, FactSet analysts had estimated second quarter earnings to be up 63.1% year-over-year. Of the 345 S&P 500 constituents that have reported so far, approximately 87% have surprised to the upside. Despite this strength at the bottom line, many of these companies have seen their stock prices fall post-reporting, implying true expectations, following the historic 41% run over the last year, were actually higher. Reopening optimism started to drive stocks, and multiples, higher in late 2020, ahead of earnings growth, and now investors are trying to determine how much future earnings growth is already priced in. We saw something similar after the Global Financial Crisis in 2009 and 2010. As the economy began its initial recovery, strong returns in 2009 preempted 40%+ earnings growth, and a sharp correction in multiples, in 2010. Importantly, in the years that followed, despite a slowdown in earnings growth, the market continued to post positive annual returns until the late-year drawdown in 2018.

This year, we may see earnings growth peak in the second quarter, but it isn’t necessarily cause for concern. Company earnings are expected to remain stable as regions continue to reopen and overcome supply and demand shocks. And, more importantly, active investment managers who have struggled to keep up with a sentiment-driven market could see an improved stock picking opportunity set. To the extent optimistic exuberance is in the rearview, stocks should be more driven by company-specific fundamentals than by macro-centric tailwinds, a positive for many of our recommended managers.

Print PDF > What Might an Earnings Peak Mean?

The opinions expressed herein are those of Marquette Associates, Inc. (“Marquette”), and are subject to change without notice. This material is not financial advice or an offer to purchase or sell any product. Marquette reserves the right to modify its current investment strategies and techniques based on changing market dynamics or client needs.