The S&P 500 Index ended 2020 by increasing 13% over the final two months. Cyclical industries like Energy and Financials outperformed while defensive industries like Utilities, Real Estate, and Staples lagged. We have mentioned in several of our recent posts (here, here, here), that as long as the U.S. economy remains on the path for economic and earnings growth to improve in 2021 compared to 2020 and vaccines continue to be distributed and taken, financial markets should be able to look past near term weakness.
Looking at recent futures and options positioning would suggest that some investors remain concerned about the near-term outlook. The Commodities Futures Trading Commission (CFTC) updates net futures positioning each week. By looking at the non-commercial positioning, we can get an idea of how investors are allocated in the futures market. The most recent update shows that investors are still hedging some of their exposure as the S&P 500 and Dow Jones net positioning is negative. The Russell 2000 positioning is net positive but is below the 3- and 6-month averages, and in-line with the 1-year average.
In the fixed income market, the net positioning in the 10-year Treasury is still long and is well above the recent averages and the 1-year average. Positioning in other parts of the Treasury market are still net short but are less than they have been in the last three to six months.
In the commodities market, positioning is net long across all commodity types, but none of them are more than two standard deviations above their 1-year average (which would be a sign of extreme positive sentiment) or at a 3-year high.
The most extreme bullish positioning in the futures market is the 3-year high net short position in the U.S. dollar ($US). Typically, the $US lags other currencies during periods when the economy and assets are increasing.
By looking at options market data, we can see how much investors are willing to pay for hedges in real time. By comparing implied volatility (based on 30-day options) to realized options (based on the prior 30-day volatility of the underlying security), we get an idea of whether investors are paying a premium (implied volatility is higher than realized) to hedge their exposures.
Looking at the implied versus realized volatility as of the end of the 2020, we observe some very large premiums in indices like the S&P 500 and Russell 2000 compared to discounts at the start of December. In the CFTC futures update, positioning in the NASDAQ was net long, but when looking at the options data for the NASDAQ 100 ETF (QQQ), the S&P Technology Index (XLK), and the largest NASDAQ company stocks (Apple, Amazon, Microsoft, Facebook, Alphabet), we see they also have large, implied premiums compared to discounts a month ago. This shows that while investors are long tech stock exposure in the futures market, they are hedging their positions in the options market.
If the economic and earnings data continue to improve into 2021 and the vaccine availability starts to lower outstanding cases and increases mobility, investors may need to start reducing their hedges and getting more aggressively positioned. This could lead to a continuation of the strong market performance of the last few months.
The views expressed herein are presented for informational purposes only and are not intended as a recommendation to invest in any particular asset class or security or as a promise of future performance. The information, opinions, and views contained herein are current only as of the date hereof and are subject to change at any time without prior notice.
Senior Vice President, Investment Strategy
Boyd Watterson Asset Management, LLC