What is Beginning to Be Priced In?

Equity markets have endured a punishing stretch. The S&P 500 has sold off sharply from its highs, sentiment has deteriorated, and the macro backdrop, to put it mildly, remains unsettled. In environments like this, our base human instinct is to focus on what could go wrong next – and unfortunately there is no shortage of candidates.

But markets are a forward-looking mechanism. We as investors, should not ask ourselves what is happening now – rather what is beginning to be priced in? On that note, there are several technical indicators now suggesting we are closer to a market bottom than most think.

The VIX index measures the level of expected volatility in the S&P 500 Index. It is a fantastic sentiment indicator and can help us determine the amount of “fear” in the market. Fewer investors track the VVIX, which measures the volatility of the VIX itself. Think of it as the fear gauge’s fear gauge. The ratio of VVIX to VIX reached extremely low levels in March, over 3 standard deviations below its 3-year rolling average. Such a low reading tells us that fear is already well-established and priced into equities. Historically, this is a constructive sign – as readings below -1.5 are indicative of strong forward returns.

Intermediate-Term Moving Average Breadth

Another interesting data point is tied to intermediate-term moving average breadth. The chart below displays the S&P 500 price index overlayed with the percentage of S&P 500 stocks trading above their 50-day average. As the stock index formed new lows in March, this breadth indicator formed a higher low. That is a classic bullish divergence. It means fewer stocks are participating in the second leg of the decline than participated in the original decline. That is how exhaustion tends to look in the data - and it typically precedes a shift in prices.

Short-Term Moving Average Breadth

We’re seeing the same divergence play out in short-term moving average breadth. The chart below displays the S&P 500 price index overlayed with the percentage of S&P 500 stocks trading above their 20-day average. Not only did this indicator fail to form a new low, but it’s recovered nicely above 50%.

None of this dismisses the genuine headwinds that remain. The macro environment is uncertain, and it would be premature to declare the all-clear. After all, the S&P 500 Index remains below its long-term 200-day moving average. There’s still a lot required to resume trend.

But the weight of the evidence is shifting. A VVIX vs. VIX Z-score at decade-level extremes, combined with a positive breadth divergence, is not a combination that shows up randomly. It has historically preceded meaningful recoveries in the S&P 500. Whether this translates to a resumption in the primary trend is still very much to be determined.

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