The Equity Hedging Index shows that the market participants are not expecting the market to go through a major correction during the next several months. The index is currently showing one of the most complacent readings ever.
There are many ways in which an investor or speculator can hedge against a stock market decline, among them:
- Raise cash
- Buy put options
- Buy an inverse exchange-traded fund
- Buy an inverse mutual fund
- Sell short a futures contract
- Buy credit default swaps
The Equity Hedging Index looks at each of those factors above and compares the current level to its historical average. The more each indicator shows hedging activity, the higher the Equity Hedging Index will be.
According to the last 5 years of history, there have been a number of extreme levels of complacency among the market participants. The 2015 case led to a multi-months chop followed by a -15% correction. The 2017 case, however, didn’t have a negative effect on the stock market and the SPX rallied all the way into the early 2018. The 2020 case, on the other hand, led to the -30% bear market.
What will happen now in 2021? Will the market disregard this unprecedented level of complacency or will we see another significant correction in the second half of 2021? As always, it will depend on whether the indices — primarily SPX and NDX — will drop below their key pivot levels (4000 on SPX and 13000 on NDX).
The Equity Hedging Index and SPX