By Greg Lai and Alex Hsiao, Co-Chief Investment Officers
Well-known fear gauge on the rise
Throughout the first half of 2024, there’s been plenty of uncertainty around Fed policy, elections happening around the world, and geopolitical tensions in Europe and the Middle East—you name it. But what we haven’t seen nearly as much of is the typical manifestation of that uncertainty in financial markets: volatility. In recent weeks, though, that looks like it could be changing. Last Wednesday, the CBOE’s option-implied measure of market turbulence, the so-called ‘VIX,’ spiked by 3.3 points, its biggest daily jump since March 2023. In the last two weeks, the VIX is 32% higher.
Volatility low relative to past levels
Of course, it’s all relative, and things look different if one compares these recent moves with a longer history for the VIX. Even though investors’ perceived stress has been way up over the past couple of weeks, it’s still low historically. Indeed, when plotted against over two decades of readings on the VIX (see chart), it’s clear the recent flashes of volatility are still way below levels seen in past episodes of increased market choppiness.
Indeed, one might have imagined a narrowly failed assassination attempt on a former US president during a campaign rally—one of the events precipitating this recent bout of volatility—putting markets a bit more on edge. Back in April, a combination of fears over escalating Middle East conflict and interest rate uncertainty caused a slightly bigger spike in the VIX. Still, even that mini-peak to around 19.2 was short of its long-run historical average of 19.5.
Technical factors to blame?
Experts have pointed to a number of things that might be artificially suppressing the VIX, which is based on the prices of publicly traded stock options. The increased popularity of zero days to expiry (‘0DTE’) options by speculative traders seeking outsized leverage, for example, might have sapped volume away from the one-month options on which the VIX is based. A recent paper by researchers at the Bank of International Settlements suggested its demand for covered call writing strategies, the hedging of which mechanically dampens volatility.
Anxieties around Q2 earnings
Regardless of what might be leading the VIX toward a lower average against a fraught macro and geopolitical backdrop, investors ought to take notice when it jerks higher as it has in recent weeks. One source of turbulence we’re closely watching is larger-than-usual moves in individual stock prices after reporting quarterly results. Extraordinarily high expectations this earnings season and some notable releases have led to big declines: Tesla’s miss, for example, or Alphabet’s Q2 beat paired, unfortunately, with disappointing guidance.
Volatility creates tactical opportunities
We’ve added some risk in our models as US economic conditions seem to bring us closer to inevitable rate cuts—maybe not in September, but hopefully by year-end—though we haven’t been shy about pointing out elevated valuations for some stocks in the face of a range of real threats: from downside surprises on the macro front to continued geopolitical instability likely to be exacerbated in an election year. For tactical investors seeking to put capital to work, trends in volatility suggest to us there may be some interesting opportunities ahead.
Election Volatility
Politics helping boost the VIX?
In our remarks above, we made more than one mention of politics, and there’s been no lack of uncertainty in the political domain since late June. After President Biden’s terrible performance in a late-June debate against then-opponent and former President Donald Trump, we discussed what a second Trump term might look like for investors. A lot has happened since then, and it’s especially interesting to discuss in the context of the VIX. Below, we share some interesting research from Bank of America, directly connecting volatility to US presidential elections.
Researchers on Bank of America’s equity quant team calculated monthly average volatility over the last 24 election cycles and looked at how market stress fared over the typical timeline entering a race’s home stretch. It turns out volatility historically increases from July to November in an election year, falling back down to earth in December after polling uncertainty shakes out and the path forward is clearer. If that pattern holds, we might expect the VIX to trend up over the next few months on our way to the polls later this year.
Harris’ ascension doesn’t surprise us
As for the so-called ‘Trump trade,’ how have things changed in the days since our last election-related dispatch? We couldn’t have imagined there would be an attempt on the former president’s life—though we might have expected his lead over Biden to improve in the wake of the failed assassination. Our commentary did tip Biden’s likely exit from the race and his replacement by current VP Kamala Harris, who seems to have locked up the nomination more or less.
Trump still the one to beat in November
Judging by prediction market probabilities, Harris has marginally improved the Dems’ chances of winning in November, though Trump is still a favorite for re-election. As of last month, the GOP was pegged at over 54% probability of taking back the White House. In this sense, things we thought might happen in the case of a Trump victory, like a steeper yield curve, a weaker dollar, and outperformance of stocks sensitive to regulation—think health care and financials—become just a shade less likely. One thing we imagine becomes more likely: that increase in volatility we just described.
Candidates likely to keep traders on edge
Markets got a taste of that policy-induced volatility just about two weeks ago when Trump opined to Bloomberg Businessweek that he blamed Taiwanese chip manufacturers for decimating America’s semiconductor industry and suggested Taiwan should be paying the US for military protection. Along with concern over bans on selling semiconductors and chipmaking equipment to China, such news was enough to send the S&P Global Semiconductor Index sliding by over 9% that week. We don’t expect that to be the last time US candidates will roil markets in the coming months.
Footnote: Reprinted and revised with permission from Rayliant Investment Research in partnership with Affinity Investment Advisors. The following article was originally published on July 29, 2024.
Advisory Services offered through Sowell Management, a Registered Investment Advisor. Trek Wealth Solutions is a division of Sowell Management. The views expressed represent the opinion of Trek Wealth Solutions. The views are subject to change and are not intended as a forecast or guarantee of future results. This material is for informational purposes only. Information provided on this website is not intended to be, nor should it be construed or used as investment, tax or legal advice, a recommendation, or an offer to sell, or a solicitation of an offer to buy, an interest in any security or cryptocurrency. Past performance is not indicative of future results, and investing in securities involves risks, including the potential loss of principal. Be sure to consult with a tax, legal, or financial professional before implementing any investment strategy. While Trek Wealth Solutions and Sowell Management believe the information to be accurate and reliable, we do not claim or have responsibility for its completeness, accuracy, or reliability. Statements of future expectations, estimates, projections, and other forward-looking statements are based on available information and Trek Wealth Solutions and Sowell Management’s view as of the time of these statements. Accordingly, such statements are inherently speculative as they are based on assumptions that may involve known and unknown risks and uncertainties
