The S&P 500 ended last week flat after partially recovering from a steep sell-off that began a week prior and intensified on Monday. The decline was triggered by weak economic data, with factors such as deleveraging, crowding, and poor liquidity likely exacerbating the downturn.
Amidst the market rout, both stock correlations and volatility surged sharply. Specifically, the VIX index of implied volatility spiked to an intraday high of 66 on Aug. 5, a level only surpassed during the March 2020 sell-off and the 2008 Financial Crisis.
However, according to Goldman Sachs (NYSE:GS) strategists, historical patterns indicate that over the next few months, "both stock correlations and implied volatility will only gradually recede back to 'normal.'"
In 12 similar episodes since 2000, when Cyclicals lagged Defensives by more than 5 percentage points within a week, it signaled a marked rise in economic growth concerns. Like in the past week, these periods were marked by large spikes in both volatility and correlations.
"Following these scares, on average both realized correlations and implied volatility, as measured by the VIX, declined slowly and remained well above pre-scare levels even 3 months later,” strategists noted.
Moving forward, the direction of the equity market will depend on upcoming data releases that clarify the economic outlook, determining whether the market remains macro-focused or shifts back to the micro-driven environment seen in the first half of 2024.
Strategists believe that labor market and consumer data “will be particularly important."
While the next jobs report is not due until September 6th, investors will closely watch weekly jobless claims, retail sales, and Walmart (NYSE:WMT)'s earnings next Thursday, as well as the labor components of Federal Reserve surveys later this month. Inflation data is expected to play a less significant role unless there are extreme upside surprises, according to Goldman Sachs.
"If the data confirm our economists’ optimistic view, investors will likely pivot back to focusing on alpha opportunities rather than market betas,” strategists wrote.
“If economic fears continue to fade and the market becomes more micro-driven in coming months, then the recent sell-off represents an attractive opportunity to buy stocks with healthy fundamentals at valuation discounts,” they added.
Historical precedent suggests that implied volatility will remain relatively elevated leading up to Election Day, though a focus on the implications of specific policies could help increase sector and stock dispersion.