Options Pros Are Worried About S&P 500 Rally’s Staying Power

Options Pros Are Worried About S&P 500 Rally’s Staying Power

(Bloomberg) — Investors are showing growing doubts about the resilience of the US stock market’s advance as the calendar flips to a historically feeble stretch and questions swirl around the prospect of Federal Reserve monetary easing.

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The S&P 500 Index has gained almost 11% to start the year, posting a string of record highs on the back of a resilient economy, improving corporate earnings and generally cooling inflation, not to mention torrid demand for shares linked to the artificial-intelligence boom. It’s the third-best January-May stretch since 2000.

There appears to be waning confidence that Big Tech can power stocks even higher, given that investors are beginning to pay up to hedge for a possible selloff. In the options market, the cost of contracts protecting against a 10% decline in the SPDR S&P 500 ETF Trust, the largest exchange-traded fund tracking the index, in two months is near the highest level since October relative to the options that profit from a 10% rally, data compiled by Bloomberg show.

“AI has been the driving force for stocks, but now it’s been overwhelmed by increased uncertainty with interest rates and inflation,” said Sam Stovall, chief investment strategist at CFRA, whose year-end S&P 500 price target implies a roughly 2% gain. “Although June is historically a pretty dull month, I’m nervous that a 5% decline in stocks from here is far more likely than a comparable advance.”

With the Fed in a blackout period before its June 12 decision, the pivotal question for equities traders remains the timing of potential easing. The central bank’s preferred measure of underlying US price pressures moderated in April, but officials have been signaling that they intend to keep interest rates higher for longer to tame inflation.

This next Fed meeting brings an update of policymakers’ rate projections, after they forecast three 2024 cuts on average in March. Meanwhile, swaps contracts tied to upcoming Fed meetings don’t fully price in a quarter-point rate cut until December, so potentially just one reduction this year. Next week’s monthly labor report looms as a key data point before the Fed gathers.

In a sign of what’s at stake, the options market is bracing for the biggest implied move for the S&P 500 on a Fed decision day since December, according to Citigroup Inc.

While stocks have wobbled of late, with the S&P 500 snapping a five-week advance, the index has notched 24 records this year — making it the second-strongest January-through-May period since 2000 by that measure, after 2021, data compiled by Bloomberg show.

The blistering run has been propelled by the S&P 500’s information technology and communication-services sectors, which house a handful of the tech behemoths, including Apple Inc., Nvidia Corp. and Alphabet Inc. Information-tech stocks have advanced 17% in 2024 and communication services by 20%. Utilities have rallied 14%, fueled by bets on demand for new data centers as part of the ascent of AI.

Of course, investors are on the lookout for a possible “June Swoon,” since it’s typically a weak period, with the S&P 500 averaging a gain of just 0.1% since 1950, making it the fourth-worst month, per the Stock Trader’s Almanac. It’s been better lately, as the index has posted June losses just twice in the past decade.

Looking past June, US stocks may be headed for a period of relative placidity, with lower trading volumes. Since 1945, the S&P 500 has risen 1.6% on average from May’s Memorial Day holiday to Labor Day in September, according to CFRA data. It’s been a different story in presidential election years since World War II, when the index gained 3.7% on average in that span. Granted, election-year rallies have often started as investors gained conviction around the winner of the presidency.

The wild card around the coming months this time around, of course, is the Fed. There’s also a sense of unease emerging from company executives. Sentiment among Corporate America’s largest firms cooled slightly in the first quarter due in part to rising commodity prices and market volatility, a move that has typically coincided with a consolidation in stock prices, according to Bloomberg Intelligence.

“There’s been such a big run in stocks and now we’re seeing investors take risk off the table,” said Kathryn Kaminski, chief research strategist and portfolio manager at AlphaSimplex. “People are wondering what’s next after the S&P 500 has come this far. When it’s unclear what to focus on, the risk then becomes what do we not see coming?”

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