A stock in your portfolio drops 10% in a day on no news. Simultaneously, another stock in that same portfolio pops 10% right before it’s set to report earnings. You might ask: “Who’s actually trading this, and why?
There are multiple players who participate in the same market. Different players with different objectives and time horizons. Let’s dive into a few of these. First, you have retail investors: years to decades of time horizons, with the goal of building wealth for either retirement or other personal goals. Next, you have large retirement/pension funds and endowments, which operate on very long-time horizons. Then you have hedge funds and quantitative trading houses, which run on short to medium time horizons, as short as seconds to weeks. Quant shops in particular are driven almost entirely by statistical signals with little to no “belief” behind the stocks they are trading. They are not concerned about valuations or the fundamentals of the companies they are trading.
Here’s why this matters for the individual investor: the day-to-day movements work drastically different than they did even a decade ago. Short-term price moves are often mostly mechanical. Algorithms and computers making programmed trades, whether that’s rebalancing, margin calls, options activity, or index fund purchases. All these transactions have very little to do with a company’s fundamentals or long-term outlook. We have seen these short-term price movements become more frequent.
The VIX measures the implied 30-day volatility of the S&P 500 index. The S&P 500 index is market-cap-weighted, meaning the mega-cap tech stocks like Nvidia, Apple, and Google heavily skew the index. With the top 10 names listed below in the chart making up almost 40% of the entire index. Worth noting, listed next to each of the individual names is their respective volatility. Most of the individual company stocks in the top 10 have a higher volatility than their overall sector does.
Daily trading volumes from quant shops, systematic strategies, and automated algorithms account for roughly 70% – 80% of total trading volume in the major equity markets in the United States. Recently we’ve seen a growing gap between the VIX and VIXEQ, the Cboe’s equal-weighted S&P 500 volatility gauge. When VIXEQ runs well above the VIX, it means single stocks are priced for much bigger moves than the index itself. Below is a chart from Bloomberg showing the two measures overlayed looking back two years.
The two have for the most part moved together but recently there has been a divergence between the two lines. As you zoom in, the spread between VIXEQ-to-VIX has widened.
This has been especially visible among the AI capex names and the various companies that have benefited from the spending. Specifically, the list of companies heavily associated with the data center build out phase. This tells us something specific: these companies are moving on their own individual stories, one beats and rallies, another misses and drops, rather than all moving together on one shared AI narrative. Because those moves are offsetting, the index stays relatively calm even as those individual stocks swing.
The combined AI capex spending has climbed steadily since the data center build-out has begun. The continuous spending leads many investors to believe the AI adoption story isn’t going anywhere anytime soon.
But a durable long-term narrative doesn’t always equate to day-to-day trading. Even within that theme, individual companies are being judged and valued differently. The market is looking very closely at each of their quarterly results and guidance pertaining to their involvement in the greater AI theme. Which is exactly why you are seeing one name jump and another drop on the same day.
We live in the digital age and narratives can change very quickly. Institutions, specifically computers, are trading the news and headlines – not actual people anymore. Reacting emotionally to these day-to-day price movements means you’re possibly making decisions based on someone else’s time horizon, not your own. If you’re a long-term investor making a decision based on the moves of other individuals’ operating with far shorter-term objectives, it can greatly impact your ability to build wealth in the stock market over time, which is the end goal for most retail investors.