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Blue Water Risk Outlook

Conrad Gann     Richard Ling

David Santschi     Drew Tilley  

August 20, 2025

Top 10% of Stocks Equal to 68% of Beta-Weighted Market Cap of S&P 500

As of August 18, 2025, the S&P 500 shows significant risk concentration: the top 50 companies (10%) represent 68% of the index's total beta-weighted market cap, far exceeding their 56% simple market cap share. This amplification highlights the influence of high-beta tech and communication stocks. This concentration has dramatically increased since 2019-2020, reaching a peak of 0.68 by 2021, driven by the AI boom, speculative fervor, and accommodative monetary policies, with notable gains in Nvidia, Tesla, and Meta. Despite a 2022 pullback, the ratio rebounded to 0.68 by mid-2024. This 20-25% rise in relative risk since 2016 lows (0.55) indicates top-tier stocks with betas over 1.2-1.5 are increasing overall index vulnerability. The widening gap between beta-weighted and simple market cap lines, especially during bull runs, is clear. This concentration raises portfolio vulnerabilities for passive investors and signals elevated tail risks—especially with persistent inflation.  Value investors might consider underweighting concentrated indices for equal-weighted or sector-diversified strategies, while monitoring laggard sectors like Energy and Utilities for mean reversion.

Wall Street Parties into Late Summer.  Industrials, Health Care, and Technology Best Performers Post-“Liberation Day.”  Advance/Decline Far More Favorable in Utilities Than in Any Other Sector.

Both U.S. stocks and U.S. bonds have been cruising into late summer as Wall Street players hit the Hamptons.  While there is no shortage of risk in the world these days, U.S. markets continue to shrug it off, even as inflation accelerates and valuations reach ever loftier heights.  The VIX ended last week at 15.1, slightly above the eight-month low of 14.5 on August 13.  Meanwhile, U.S. credit markets remain on fire.  Bloomberg reports that leveraged loan issuance has set a record for August, and the spread on investment-grade corporates to Treasuries narrowed last week to a mere 73 bps, the lowest level since 1998.

The Trump Administration’s autocratic, erratic policymaking resembles that of a developing country rather than a superpower.  With the Administration placing its bets squarely on the Big Tech/AI/crypto bubble complex, it is no surprise that even Treasury Secretary Scott Bessent is clamoring for big Federal Reserve rate cuts even though both consumer and producer price inflation is accelerating and inflation has exceeded the Fed’s supposed 2% target for years.  Investors should be far more concerned about inflation than growth as credit conditions remain exceptionally loose and the U.S. government keeps deficit spending at about $150 billion per month.

Taking a longer-term view, U.S. stocks have marched higher with few interruptions since U.S. President Donald Trump backed off of his “Liberation Day” tariffs.  Industrials, Health Care, and Information Technology have performed best, while Real Estate, Energy, and Consumer Staples have lagged.

We always like to consider market breadth as well as returns.  One key measure of breadth is the advance/decline ratio, which compares the number of advancing stocks to the number of declining stocks (it rises when advances exceed declines and falls when declines exceed advances).  We calculate it at the sector level based on data from FactSet.

The advance/decline data so far this year has had a defensive tone.  It has been by far the most favorable in Utilities, likely reflecting demand for power for AI data centers, trailed at some distance by Communications.  Breadth has been worst in Health Care.

Risk Spotlight: Value Investors Should Consider Contract Drillers, Sixth-Worst Performing Industry This Year.  Betas of Largest U.S. Publicly Traded Contract Drillers Rise This Year.

In our August 4 issue, we advised value players to turn their attention to Health Care, particularly health insurers.  Some have already swung into action, including Warren Buffett’s Berkshire Hathaway, which revealed after last Thursday’s close that it initiated a position in UnitedHealth Group.  Berkshire has not been the only buyer.  David Tepper’s Appaloosa Management and Stephen Mandel’s Lone Pine have also boosted their holdings significantly.  UnitedHealth Group’s stock popped 12.0% on Friday after rising for much of the preceding two weeks along with the shares of other major health insurers.

Our point here is not that our timing will always be impeccable.  Our point is that beaten-down industries often draw the attention of deep-pocketed value investors, whose buying can propel stock prices sharply higher after long slumps.

Another battered industry worth consideration by value investors is oil and gas contract drillers.  Energy is the second-worst performing sector this year, with crude oil prices down 12% and natural gas prices down 19% amid plans by OPEC+ for production increases.  As Blaine Rollins recently pointed out, Energy trades at a forward P/E of 15, the lowest of any sector, and its forward P/E relative to the S&P 500 is in the 20th percentile in the past 30 years.  Energy accounts for 6.7% of U.S. GDP but is equal to only 3.1% of the market cap of the S&P 500.

Contract drillers have been the sixth-worst performing industry in the S&P 500 this year, down almost 20% year-to-date.

The largest publicly traded U.S. contract drillers–Noble (NE), Sable Offshore (SOC), Patterson-UTI Energy (PTEN), Seadrill (SDRL), and Helmerich & Payne (HP)--have been under pressure for much of the past two years.  The only exception has been Sable, which has dramatically outperformed but with very high volatility.  Three of the five stocks have delivered negative returns since the start of this decade.

The graph below shows the betas of each of the contract drillers since 2000.  The betas of all five firms have increased this year, and they all currently exceed 1.

The next graph decomposes the variance of each of these stocks, with the width of the bars scaled based on market cap.  The variance of the stock with the highest beta, Sable, is almost all residual, while the variance of the other four stocks is much more balanced.

Blue Water can provide daily data on exactly what to hold each trading day to hedge the risk of any U.S. stock.  For further information, please contact support@riskmodels.net.

Blue Water Expands Sector Volatility Analysis with Variance Risk Premiums in Partnership with SpiderRock Data & Analytics.  

Through our partnership with SpiderRock Data & Analytics, Blue Water has expanded its volatility research to include the variance risk premium (VRP)—the spread between option-implied and realized variance—across U.S. equity sectors. VRP measures how markets price variance risk relative to actual volatility outcomes, providing insight into sector-specific risk aversion and forward-looking uncertainty.

Cross-Sectional VRP Dispersion

The cross-sectional snapshot in the following figure highlights significant dispersion across sectors.

• Information Technology and Consumer Discretionary show the highest VRP levels (≈0.075–0.085 on the 252-day horizon) and elevated earnings event ratios (>6%), reflecting uncertainty tied to AI transformation, consumer demand, and earnings cyclicality.
• Energy has the lowest VRP (≈0.015), suggesting variance risk is priced more efficiently in commodity-linked sectors where realized volatility often tracks implied expectations.
• Defensive sectors such as Consumer Staples, Healthcare, and Utilities sit in the middle range, consistent with their stable business profiles but still carrying meaningful variance premia.

Historical VRP Regimes

Sector VRP time series reveal distinct volatility regimes since 2020:

• Early COVID-19 brought extreme VRP spikes across all sectors, followed by divergent recoveries. Energy saw periods of negative VRP in 2021 amid commodity dislocations.
• By 2022, VRP levels converged toward 0.05–0.10 across sectors as macro risks (inflation, rates, geopolitics) dominated.
• Since 2023, Technology and Discretionary have remained elevated while defensive sectors moderated, signaling a shift back to idiosyncratic sector risk pricing.

We estimate predictive regressions of the form:

where rᵢ,ₜ→ₜ₊ₕᵉˣᶜᵉˢˢ is the forward excess return of sector i over horizon h, and VRP(h)ᵢ,ₜ is the variance risk premium at horizon h. Predictive power is assessed using the regression’s R², both in raw returns and in market-neutral specifications.

Overall, the variance risk premium shows heterogeneous predictive power across sectors, underscoring that markets price variance risk in fundamentally different ways. Consumer Discretionary stands out with a strong negative long-horizon relationship: elevated VRP has historically signaled weaker forward returns (β = –4.02, R² ≈ 39% over 24-month horizons in the market-neutral specification). Real Estate displays a maturity-dependent pattern, where short-term VRP (6-month) is positively related to returns but longer-term VRP predicts weaker outcomes, reflecting the sector’s sensitivity to refinancing costs versus long-duration risk. In contrast, Energy exhibits a positive short-horizon signal, with 1- to 6-month VRP reliably predicting mean-reverting gains after commodity-driven volatility shocks.

Importantly, VRP’s predictive power strengthens once broad market effects are removed, highlighting that sector-specific risk pricing carries information not captured by aggregate risk appetite. From a tactical perspective, elevated VRP in Discretionary and long-dated Real Estate may warrant underweights, while positive short-term VRP in Energy could identify contrarian entry points. Today’s cross-section shows Technology and Discretionary at the top of the VRP spectrum, reflecting heightened growth-sector uncertainty, while defensive sectors cluster at moderate levels. Taken together, the patterns reinforce that VRP is a valuable lens for identifying sector-specific risk premia and timing opportunities, particularly when integrated with our earnings-event volatility framework.

To test these datasets, please contact support@riskmodels.net for a free trial.

BetaWatch: Trump Grift Plays Palantir and Coinbase among 25 $2+ Billion Market Cap U.S. Stocks with Highest Betas.

Our BetaWatch feature highlights the 25 U.S. stocks with a market capitalization of at least $2 billion with the highest betas relative to SPY.

Two of the biggest direct plays on the Trump Administration’s grifting–Palantir and Coinbase–are among these stocks.  While Tesla’s beta is the fourth-highest, Nvidia has slipped to nineteenth place.

Feel free to reach out directly to any of our interns if you are seeking to hire up and coming financial engineers!

Regards,

David Santschi

Blue Water Macro

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