Edward Curran, centre, works with fellow traders on the floor of the New York Stock Exchange, Tuesday, Sept. 6.Richard Drew/The Associated Press
They can't both be right.
Below the surface of the calmest stock market in five decades, a divergence in sentiment has opened in which institutional investors are surrendering hedges and diving deeper into stocks, while individuals load up on protective options and sell equity funds. Bets are piling up at the fastest rate ever as stocks meander, setting the stage for pain when the sleepy spell resolves.
The trading reflects a bigger picture in which professional investors warm to an advance that lifted the S&P 500 Index almost 20 per cent since February, even as individuals are unconvinced. Chris Bouffard, who oversees $10-billion as chief investment officer at Mutual Fund Store in Overland Park, Kan., says this time the pros have it right.
"The reaction throughout this year is realizing the Fed is going to be lower for longer than even the most dovish people thought," said Mr. Bouffard, whose firm anticipated the rally in riskier assets like high-yield bonds and emerging-market stocks this year. "If you're retail without the research and insights into the fundamentals of the economy and geopolitical events, you're at whims of headlines, the emotions and sensations that come from them."
The depth of the divide is illustrated in options markets, where institutions are bailing out of bets volatility will increase while smaller investors embrace them.
The S&P 500 rose 0.5 per cent to 2,178.91 at 11:01 a.m. in New York, while the CBOE Volatility Index slid 2.3 percent, ending a five-day advance.
On futures exchanges, venues dominated by hedge funds, bulls are going all in on the end of market turbulence. Net short positions in the VIX reached a record this month, Commodity Futures Trading Commission data show. At the same time, net long positions in contracts linked to the S&P 500, Nasdaq 100 Index and Dow Jones Industrial Average totaled as much as $57 billion, the most in CFTC data compiled by Sundial Capital Research Inc. since 1986.
Equally enthused are retail investors whose appetite is growing for exchange-traded products tied to levels of equity swings. Take the iPath S&P 500 VIX Short-Term Futures ETN, the biggest security tracking the volatility gauge, a position that amounts to a stock-market short. Outstanding shares have exploded 11-fold since January to an all-time high this month, and the note took in $816 million of fresh cash in July, the most since 2012.
With conviction running high, open interest on SPDR S&P 500 ETF options - both bullish and bearish - climbed above 27 million contracts earlier this month, the most since 2011. Outstanding calls and puts have averaged about 18 million since the start of the bull market.
That Wall Street should disagree with Main Street is nothing new, though the discord has rarely been this pronounced. For individuals, withdrawing money from stocks has meant missing out on a rally that restored $3.7 trillion to U.S. share values since February -- though a similar bout of prudence paid off before the rout of last August. Professional investors bore the brunt of that selloff, in which the S&P 500 posted its first 10-per-cent drop in four years, and have been beneficiaries of this one.
A seven-year advance in which the S&P 500 rallied about 220 per cent qualifies as the second-longest bull market ever, and it may not be surprising that investors are increasingly at odds. For bears, elevated valuations and falling profits are sounding the rally's death knell, while evidence of improving economic growth and central-bank rescues have renewed faith among those who lived though two corrections in six months.
Ironically, a byproduct of the polarization has been the extraordinary calm for the major averages. The S&P 500 has been locked in a 1.5 percent range over the past 30 days, the smallest fluctuation since 1965. Prices of options to hedge against equity swings, almost entirely a function of volatility in the indexes, are plunging. At an average of 12.29, the VIX is trading lower than any August since 1994.
"We're not seeing a one-sided trade," Jim Paulsen, chief investment strategist at Wells Capital Management, which manages about $350-billion, said. "The market action as a whole reflects, at best, middling sentiment. I can certainly see how people are that way, based on seasonals and the uncertainty from the Fed."
The skepticism of individuals is also evident in money flows. Since December, almost $90 billion has been withdrawn from mutual and exchange-traded funds, according to data compiled by Investment Company Institute and Bloomberg. That exceeds outflows from all but one year at this point of time in data going back to 1984.
"If you stayed invested for the last few years and you have a lot of money invested, from that perspective it's perfectly normal for retail investors to take their money off the table," said Ram Gandikota, who helps oversee $1.5-billion as senior portfolio manager at Ativo Capital Management LLC in Chicago. "But to completely take your gains out and then go toward a short position on the market and have a negative view, it's probably too soon."
Institutions have largely given up on bearish positions. According to a Bank of America Corp. survey, money mangers owned more U.S. equities than are represented in benchmark indexes in July and August, after holding an underweight position for 16 straight months. They also scooped up shares that benefit most from an economic recovery, with cyclical holdings climbing to the highest level since 2012 relative to defensive ones, the firm said.
That last time retail and professional investors disagreed on the VIX's direction, it was the little guys who proved right. During the first half of 2015, hedge funds sold out of equity insurance while retail investors turned cautious. Then in August, the VIX saw its biggest two-day spike on record.
To Terry Morris, a senior equity manager who helps oversee about $3.2-billion at Wyomissing, Pa.-based National Penn Investors Trust Co., the lack of consensus is one reason why the bull market will keep going because bears will be lured back by higher prices.
"It's healthy to have conflicting views," he said. "We have a lot to worry about, and there are still a lot of people on the sidelines. A lot of people got scared out, and now they're watching the train slowly leave."