(Updates with close of Friday trading, adds details on VIXperformance history)By April JoynerNEW YORK, Feb 5 (Reuters) - As the trading frenzy inGameStop Corp shares and other social media favoritesrecedes, investors are eyeing signs of potential market stressthat could weigh on broader stock performance in coming weeks.For now, U.S. equities appear to be looking past last week'ssurge in volatility that led the S&P 500 to its biggestweekly decline since October. Solid earnings, fiscal stimulusexpectations and progress in country-wide vaccination effortsare leading stocks back to all-time highs.The S&P 500 and Nasdaq posted records for a secondstraight session on Friday. Some investors, however, worry that the wild swings inGameStop and other "meme stocks" may have exacerbated concernsover market volatility and elevated valuations that could makemarket participants more risk-averse. The S&P 500 stands nearits highest forward price-to-earnings ratio in about two decadesafter rallying 74% from its March lows."The recent retail activity was concerning for the broadermarket," said Benjamin Bowler, head of global equity derivativesresearch at BofA Global Research.Liquidity in futures on the S&P 500 dried up asmarket makers and other investors sought to reduce risk duringthe GameStop surge, according to BofA analysts. Earlier thisweek "market fragility," as measured by the bank, stood at itshighest level since March 2020, making U.S. equitiesexceptionally vulnerable to sudden market shocks, the firm said.Moves in the Cboe Volatility Index , known as WallStreet's "fear gauge," also indicate that investors may be moresensitive to market turbulence than usual. On Jan. 27 the indexsurged 14 points, its biggest one-day gain since March, as theS&P 500 lost 2.6%.The fear gauge's climb was eight to 10 points greater thanthe expected move following such a drop in the S&P 500,according to Stuart Kaiser, strategist at UBS. The outsizedreaction, he said, points to heightened jitters among investorsthat could suggest bigger market sell-offs in response tonegative developments.The VIX has since reverted to its lowest level since earlyDecember as U.S. equities have rallied this week. Even so, "Iwouldn't say we're completely past it yet," Kaiser said.Next week, investors will focus on quarterly corporateresults from Cisco Systems Inc , General Motors Co and Walt Disney Co as well as data on U.S.consumer prices.Options markets have not flashed the green light to go fullspeed ahead with resuming risk.Investor demand for calls on the S&P 500, used to positionfor gains in the index, has jumped after plummeting to amulti-decade low earlier in the week, according to CharlieMcElligott, managing director, cross-asset macro strategy atNomura. The swing in demand points to risk of a pullback andchoppy trade in the next few weeks, he said.Longer-term, several market analysts say the GameStop effectmay be no more than a blip on the radar screen for markets as awhole. Drops in the VIX of 20% or more to below 25 tend to bodewell for stocks, with the S&P 500 rising 2.6% a month later,according to Christopher Murphy, co-head of derivatives strategyat Susquehanna Financial Group.Still, the exuberance that magnified the market's faultlines has not completely faded. According to data from TradeAlert, options activity shows heavy demand for upside calls inthe SPDR S&P Retail ETF , which includes GameStop, andthe iShares Silver Trust , which was also rocked byretail trading.As a result, some investors say they plan to treadcautiously for the time being, especially if they are exposed topassive funds that hold a large number of small-cap stocks thatcould be sensitive to a sudden retail frenzy.
"Time will tell whether this has a more lasting effect onthe market," said Matt Forester, chief investment officer of BNYMellon's Lockwood Advisors. "We need to police our holdings tomake sure we're not overly exposed to these trends."
(Reporting by April Joyner; Editing by Ira Iosebashvili, NickZieminski and Richard Chang)