The New York Stock Exchange on July 7. [Reuters]
The New York Stock Exchange on July 7. [Reuters]

Bank of America (BofA) has warned that patterns similar to those seen during the dot-com bubble are re-emerging, raising the risk of a sudden shock to US equity markets.

According to Business Insider on Wednesday, BofA said in a Tuesday report that "the volatility spread between individual stocks and the index has approached the extreme levels seen during the dot-com bubble."

Data released by the Chicago Board Options Exchange (CBOE) in June showed that the spread between the S&P 500 constituent volatility index (VIXEQ) and the broader volatility index (VIX) had widened to a record high.

The spread between the VIXEQ and VIX indexes has widened to an all-time high. [Chicago Board Options Exchange (CBOE)]
The spread between the VIXEQ and VIX indexes has widened to an all-time high. [Chicago Board Options Exchange (CBOE)]

The VIXEQ reflects the average volatility of individual stocks that make up the S&P 500, while the VIX — often called the "fear index" — measures broader market volatility derived from S&P 500 options prices.

As of Tuesday, the VIXEQ was hovering around 50, up 46 percent from the start of the year, while the VIX stood at 16, a gain of just 13 percent over the same period.

BofA's global equity derivatives research team noted that a similar divergence appeared in the late stages of the dot-com bubble, saying: "The volatility gap between individual stocks and the index is approaching the extreme levels seen during the dot-com bubble. The risk of a shock event materializing has grown."

The team added that "index volatility remains at relatively low levels, creating a historically rare divergence," and that "if valuations, not just share price movements, approach bubble territory, this gap could widen further and potentially surpass the extreme levels seen during the dot-com bubble."

BofA attributed the widening gap primarily to a selloff in the semiconductor sector, saying investors have been pulling money out of chip-related stocks to take profits and rotating into other attractive areas of the market.

The iShares Semiconductor ETF (SOXX), one of the funds tracking the semiconductor sector, has surged 83 percent this year but has fallen about 12 percent from its late-June peak.

The bank also said a sharp decline in the correlation between semiconductor stocks and other large-cap technology and software shares has contributed to the spread widening. BofA said the correlation between semiconductor stocks and the broader market is currently near an all-time low.

Other Wall Street institutions have also flagged the widening gap between individual stock volatility and overall market volatility as a potential warning sign for the AI investment frenzy.

US investment bank Stifel said in a recent report that past instances of a similarly wide VIXEQ-VIX spread narrowing have frequently preceded major market downturns, and that investors should prepare for the possibility of increased market volatility ahead.


bbo@heraldcorp.com