It’s Quiet… But Not “Too Quiet”

By Michael Salvatore

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VIX reaches a pre-pandemic low… Technical indicators show us the next likely move… The last major bear just turned bull… Jamie Dimon gets exactly what he wished for… The next frontier of AI gains lies in an unexpected place…

Investors haven’t been this confident in the short-term future of the stock market since… January 2020.

That is to say, investors are complacent and happy as pigs in a pen. They think stocks have an overwhelmingly large chance of running higher over the next month… or, at least, just not crashing lower.

The CBOE Volatility Index shows us this. Often called the market’s “fear gauge,” it charts investor’s expectations of volatility in the S&P 500 over the next 30 days. The higher the line, the more fearful investors are.

Here’s the long-term view, stretching back to 2019:

You can’t blame investors for the complacency. Stocks are in “up only” mode. The S&P 500 is up 6% from just the start of this month. That’s well above the historical trend, which sees stocks returning about 10% per year.

(To be fair, we’re also just emerging from a 5% correction. May 1 marked the bottom of that last down move. But stocks are still up more than 12% this year.)

So should we be fearful of a multi-year low in the VIX? Will this complacency lead to another volatility surge?

As we preach constantly in TradeSmith Daily, we should always be looking ahead to see what risks and opportunities lie before us… and we should always let data tell the story.

❖ When data speaks, we listen… 

One way of letting data tell the story is with technical indicators, which help show us how assets are behaving under the hood.

Let’s zoom in on the chart of the VIX and apply a classic technical indicator, the Bollinger Bands:

You can think of Bollinger Bands as a measure of volatility on individual assets. The wider the bands, the more volatile the asset is behaving in the short term – and vice versa.

When you apply them to the VIX, you get a unique picture that’s essentially “the volatility of volatility itself.”

You can see that throughout the first quarter of 2024, the Bollinger Bands for the VIX were pinched close together. That coincided with a face-melting rally, where investors had almost zero concern that stocks could fall. Volatility was low and wasn’t moving much.

This had an effect similar to holding an inflated beach ball underwater. When investors “let go” of the ball in April, volatility exploded higher… and the bands widened.

Volatility has since come back down, but there’s also a little less air in the beach ball, so to speak. There’s less pent-up energy in the chart of the VIX. Said another way, the volatility of volatility is higher.

So this begs the question – should we be scared of another volatility surge?

In short, no. In fact, I’d bet volatility drops even lower than here. 

We’d want to see the VIX close below its lower Bollinger Band to flash a broad stock market sell signal. If investors get too complacent with lower-than-normal volatility, they’re asking for trouble. As long as the VIX is within the bands, and the bands are wide, there’s no signal to speak of. 

Similarly, a close above the upper band would act as a broad buy signal, as the last one in late April proved to be. When volatility is stretched to the upside outside the normal bound, then it’s a buy signal.

We should also continue to look for prolonged periods of muffled volatility – like we saw earlier this year – before we consider another surge in volatility is likely. (We can see that quantified in the blue line at the bottom of the chart above – a measurement of the Bollinger Band width.)

Right now, that doesn’t seem likely – so stay bullish. Even as stories like these might make you second-guess yourself…

❖ The last bear on Wall Street just turned bullish…

And like volatility expectations at a pre-pandemic low, that’s enough to give a contrarian investor a bad case of heartburn. Here’s Bloomberg:

Morgan Stanley’s Michael Wilson now sees the S&P 500 rising 2% by June 2025, a major about-turn from his view that the benchmark will tumble 15% by December.

The strategist — whose bearish 2023 outlook failed to materialize as markets kept rallying — finally gave in and boosted his target for the S&P 500 to 5,400 points from 4,500. That catapults his forecast from among the lowest on Wall Street to one that projects a fresh record for the index.

Mr. Wilson throwing in the towel might sound like the bell ringing at the top. In reality, there are nothing but positive signs for the stock market ahead.

As Wilson says, “robust earnings per share (EPS) growth alongside modest multiple compression”– translation: Companies are earning more and that’s making their stock prices cheaper.

But we have an even bigger sign…

❖ Big money moves the market, and it’s busy hitting the buy button…

Our next big sign of a healthy market comes from Jason Bodner, editor of TradeSmith Investment Report.

Here’s Jason writing to his subscribers about the single most important factor in a healthy bull trend: the presence of institutional capital:

As you would expect, Big Money is buying again. From May 2 through May 17, my system detected an average of 98 Big Money buy signals each trading day, compared with just 36 sell signals.

In other words, 73% of all signals (both buys and sells) are buys. That’s very healthy, and we see it reflected in the moves higher in the overall market and our TradeSmith Investment Report stocks.

Eighteen of our 20 stocks are up in that time, gaining more than 7.5% on average in the last two weeks. That trend continued this week with our stocks adding more than 2% and outpacing the three major indexes.

Jason keeps it refreshingly simple in TradeSmith Investment Report. He uses his unique market-scanning algorithm to detect where the biggest institutional flows are going. Then, he pairs that up with the highest-quality mid-cap stocks and recommends them.

Simple… but as you can see from the above, very effective. Jason’s model portfolio has outpaced the market’s gain over the past two weeks, and it boasts a 90% win rate across 20 positions. Few investors can claim performance like that.

❖ Jamie Dimon talked down JP Morgan’s stock price on Monday…

Most major company CEOs would sooner step in front of an oncoming train than give any indication that they think their stock price is too expensive. But apparently, most CEOs are not like Jamie Dimon.

The leader of the biggest bank in the U.S. fielded a question about stock buybacks at the company’s investor day. It was a good question.

The investor wanted to know if JP Morgan Chase planned to use the $567 billion it has on hand for stock buybacks. Stock buybacks are increasingly popular among investors for their short-term positive price impact. It has the opposite effect of share dilution – taking outstanding shares lower and increasing the impact of dividends.

Here is Dimon’s response to the question, from Barron’s

“To make it really clear: We’re not going to buy back a lot of stock at these prices,” Dimon told attendees at the bank’s annual investors’ day. “We do not consider stock buyback returning cash to shareholders. That’s giving cash to exiting shareholders. We want to help the existing shareholders.”

You might need to read that twice. Dimon considers a share buyback a gift to investors who want to sell the stock – those exiting. He instead wants to help existing shareholders. Further:

“Hedge funds and people, they trade when the market opens, they trade when the market closes,” Dimon said. “We simply aren’t going to tell you anything anymore about stock buybacks. We’re going to surprise you all the time, OK?” he told the audience in his signature colorful tone. 

“I want to out-trade the hedge funds, is what I want to do.”

“We’ve been very, very consistent,” Dimon said. “When the stock goes up, we’ll buy less and when it comes down, we’ll buy more.”

Dimon is implying that he thinks JPM is too expensive to buy back. Investors took the message loud and clear: JPM sank more than 4% on the day, the losses further spurred by talk of Dimon’s soon-to-come retirement.

Maybe now it’s cheap enough for Dimon to consider a buyback. The selloff put JPM’s price-to-earnings ratio at just under 12, with the dividend yield now at 2.35%. You’re getting a better deal than when Dimon opened his mouth, that’s for sure.

One thing to consider, as always, is JPM’s Business Quality Score (BQS). This is TradeSmith’s finely tuned composite score to gauge a business’ underlying health.

JPM rates a middling 53, largely due to its slow or negative five-year growth rates. It’s a safe stock, to be sure, with especially low historical earnings volatility. But this picture tells us that the recent surge in JPM shares may be an anomaly. (Disclosure, I own shares of JPM.)

❖ Now this is an AI tool we can all get behind…

We’ve had our fun with large language models, image-creation tools, and even AI music over the last year.

But to be blunt… at least from my view, it’s all had the air of a parlor trick.

I can’t honestly say I’m using these tools in my day-to-day life. Call me old-school, but I prefer to rack my brain and struggle with a piece of writing rather than let a toothless AI chatbot spit out something generic for me to try and improve.

TradeSmith’s Predictive Alpha algorithm, of course, is a different story. Getting an idea of where a stock could trade in the next month is a huge leg up. And as we’ve shown time and again in these pages, major hedge funds have used increasingly advanced AIs in their trading strategies for decades. 

But you know where I’d really love to see AI? The clue is in how I sign these letters: “To your health and wealth.”

The health care field is ripe for AI disruption. With the advent of digital twin technology, it’s only a matter of time before doctors are using AI to simulate your unique genetic makeup, and even specific parts of the body, to help diagnose you more effectively.

This kind of thing sounds so far off as to not be immediately investable – something like Neuralink or SpaceX, where private investors speculate on the distant future.

But last night, 41-time 10-bagger-finding superstar investor Eric Fry proved it’s actually happening right now in public markets, right under investors’ noses.

Dedicated TradeSmith Daily readers might remember that I interviewed Eric Fry about what he’s seeing in the AI health care space back in March. Since then, he’s been hard at work uncovering the best opportunities in the field… and now he’s ready to share his findings.

In a timely research presentation aired just last night, Eric showed off everything he’s learned since he jumped down the AI health care rabbit hole – including one stock set to benefit from this underground tech hitting the mainstream consciousness.

If you haven’t already, I encourage you to check it out. Eric’s got a strong track record of finding big trends well before they become big, and this time seems no different.

To your health and wealth,

Michael Salvatore
Editor, TradeSmith Daily