Episode 3: Is Bond Volatility Warning Stocks?

Hi I’m Oliver from Refinitiv.  Welcome to Data On The Data.

Activity in the US stock market is becoming increasingly polarized between retail and institutional investors and this could have a significant impact on index volatility over coming weeks.

Individual investors have been targeting two strategies in particular. Firstly, as we mentioned last week, they have focused on small cap stocks names which have been heavily shorted. GameStop may have been the headline maker, but this strategy of buying unloved names has been implemented across a broad market. We’ve seen spectacular outperformance of Refinitiv’s US Most Shorted Stock Index versus the S&P500 over the last 6 months.

Secondly, they have been implementing many of these strategies with options, where average volumes are now over double where they were a couple of years ago, with volumes dominated by the small sized positions of the retail investor.

However when we look at the data usage of our institutional client base, specifically the equity indices, we can see that these investors have been engaging at their lowest levels of the year, even though US equity markets have been touching their all-time highs. The number of users engaged with the Nasdaq 100 is at its low for the year for both asset managers and commercial banks. This is a pattern that is repeated across other US indices, such as the S&P500 and for other institutional users, such as investment banks. 

But it's not just in the US, we can see a similar pattern in Europe where commercial bank users of the Eurostoxx 50 and FTSE100 are at the lows of the year, a pattern which is again repeated for asset managers and investment banks. While some of the explanation is a drop off in activity out of our Asian customers due to the New Year's celebrations, that doesn't explain the broad based pullback in other regions.

It does suggest the increasingly passive element of institutional investing is just running with the flow and that the emotions around the all-time highs are coming from the retail sector. But trouble could be brewing. US bond yields have been edging higher, and investors have been focusing on commodities and inflation. When we look at a measure of bond volatility called the MOVE Index and compare it with the equity volatility index called the VIX, we can see that bond volatility has diverged in recent sessions when compared to the VIX, which recently touched a one year low after the earlier effects of the GameStop short squeeze. Bond yields are flashing warning signs about risk assets just when institutional investors appear to be stepping back from the market. And that could mean that more stock market air pockets are ahead in both directions. 

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