The US stock market is in a state of "extreme weakness," and the earnings season has begun

Author: Zhang Yaqi, Wall Street Journal

The volatility at the index level of the U.S. stock market appears calm on the surface, but internal pressures are building. Under the triple pressure of geopolitical situations, monetary policy expectations, and signals from the credit market, market vulnerability has risen to a near-high in recent years—just as a season of high expectations and high-risk earnings reports is about to begin.

The "Turbu-lens" market vulnerability indicator from UBS's derivatives strategy team currently reads 0.9 (on a scale of -1 to 1), the highest level since mid-September 2025. Historically, such readings often foreshadow a sharp rise in the VIX. UBS derivatives strategist Maxwell Grinacoff's team warns that this indicator points to "extreme market vulnerability," coinciding with the start of the earnings season. Meanwhile, the team also noted that if systemic strategies fully leverage, this indicator reading "could really touch +1."

The current high expectations in the market further amplify the risks. Analysts expect a 24% growth in earnings for S&P 500 constituents in the second quarter, and a 12% expectation for the STOXX Europe 600 index. Unlike previous earnings seasons, analysts have continuously raised their forecasts on the eve of the reporting period, and such strong confidence means that if the results disappoint the market, the adjustment space will be larger.

Under VIX Calm, Individual Stock Volatility is Three Times Higher

Currently, the VIX is at a low level, but this calm is misleading. Barclays strategist Anshul Gupta's team points out that the recent decline in the VIX coincides with a seasonal calendar window when price volatility typically narrows, representing a "temporary sweet spot" with limited sustainability, and the start of the earnings season may push the VIX back up.

More concerning is that the low volatility of the index masks extreme internal market divergence—individual stock volatility has exceeded index volatility by more than three times. Grinacoff states that the likelihood of this gap narrowing in the summer is high, at which point either a repricing of monetary policy or geopolitical disturbances could trigger a sharp rise in index-level volatility.

In terms of hedging strategies, due to the potential for diversified trading and sector rotation to continue during the upcoming earnings period, the hedging effect at the index level may be limited. Grinacoff suggests that "single stock options may offer better tactical opportunities."

Oil Prices and Bond Market Issue Dual Warnings

The volatility in oil prices due to geopolitical situations is exerting continuous pressure on global stock markets. Brent crude oil prices have risen to below $80 per barrel, a trend that may keep inflation expectations high and cause the Federal Reserve to maintain a wait-and-see stance. Although changes in interest rate expectations were limited following the release of the Federal Reserve's meeting minutes, the yield on 10-year U.S. Treasury bonds has quietly risen to nearly 4.6%, and the increase in bond market volatility poses a negative signal for global stock markets, or at least suppresses further upside potential.

Citigroup's strategist team (including Alice Zheng) points out that the market currently has a misalignment in positioning for rising oil prices, particularly in Europe—due to its heavy reliance on imported energy and lower exposure to AI-benefiting assets. "If the rise in oil prices continues, the pullback in European stock markets could be quite significant, as the market has previously digested expectations of conflict resolution," the strategists wrote.

Credit Market Does Not Endorse Stock Market Rally

The performance of the credit market has sounded the alarm for the current upward momentum in the stock market. Compared to the previous record highs of stock indices, the narrowing of credit default swap (CDS) spreads has been quite limited, indicating that the credit market has not fully endorsed the stock market's rally. As the stock market has recently experienced a pullback, the two have begun to realign, but analysts believe that to support a stronger upward movement in the stock market, clearer tightening signals from the credit market are needed.

In light of the aforementioned risks, UBS recommends that investors capture individual stock volatility opportunities through pair-wise correlations trades. In terms of sectors, UBS believes that technology, energy, and financial sectors in the U.S. market are most suitable for paired volatility trading, while in the European market, energy, technology, and consumer discretionary sectors are recommended.