Looking forward and thinking about the trading environment and price direction we are likely to see between mid May and the July 4th holiday I think there are several themes at play:
Indices Drifting Higher - I think we are likely to see the major US indices drift higher from mid May thru June and into the July 4th holiday with the S&P and Nasdaq likely grinding to new highs. The DCC forward return model shows positive return expectation for the S&P 500 and Nasdaq 100 between mid May and July 4th. I think there are several ways to play this depending on your risk tolerances. One can simply buy the index tracking etf or future, sell puts or buy ratio call spreads (1 near money call while selling 2 sufficiently out of the money calls).
SPX:
Nasdaq 100:
Realized and Implied Volatility Compression - I expect realized volatility to continue to compress after the middle of May. I am expecting sub 10% realized volatility heading into June and perhaps sub 8% realized volatility in the back half of June into the holiday weekend. There are several ways to play low realized volatility. One can sell straddles, strangles or hedged options. Own one of the inverse VIX etfs like SVIX or SVXY, or short the prompt VX futures or futures spreads. We are currently expressing this trade thru the short July/September VX future spread.
Sector Rotations and Low Realized Correlations - As you can see from the sector performance chart there have been significant leadership changes across the sectors in the second quarter while the SPX performance has remained relatively flat. This shows us that money is not leaving the market it is just rotating into new assets. We can see that realized correlations continue to trend lower as well. I expect this rotational trend will continue into the end of June. It would also not surprise me to see XLU and XLP continue to do well into the end of the quarter.
Sector Performance Rankings by Quarter:
Rolling 63 Day Realized Correlation of SPX Components:
4. Yield Curve Steepening - The 5 year - 30 year (ZF-ZB) yield spread is now almost flat (@ +3.7 bps). I think as we move forward towards the election the market realizes what Stanley Druckenmiller said this morning. A Trump election means inflation and a Biden election means stagflation. Both of those scenarios demand a term premium in interest rates, especially when the Fed is going to be more dovish than it should be into the back half of the year. The way to play this trade is to buy the 5 Year future (3x) and sell the 30 year future (1x). This trade makes money if/when the yield curve steepens (adding term premium to longer dated rates).
5. Bullish Bitcoin - As we get closer to mid May I think it makes sense to get long a bit of Bitcoin (futures) if you can acquire it between $61,000 and $62,500. I expect the low equity volatility to drive traders into crypto for some summer action.
BTC:
-DCC