Growing uncertainty in the U.S. economy, a shifting Federal Reserve stance, and the approaching presidential election are driving an uptick in demand for portfolio hedging, as evidenced by recent moves in the options markets. Investors are closely watching these evolving factors that could disrupt the current stock rally.
As attention turns to Tuesday’s highly anticipated televised debate between Democrat Kamala Harris and Republican Donald Trump, the Cboe Volatility Index (VIX) has been hovering around 20—well above its 2024 average of 14.8. The VIX, often referred to as the market’s “fear gauge,” tracks demand for options that protect against swings in the stock market. Historically, the index rises by about 25% between July and November during election years, driven by investor concerns over the impact of candidates’ policy proposals, according to Bank of America data.
This year, however, the political uncertainty is compounded by additional catalysts for volatility. Concerns are mounting over a potentially softening U.S. economy and the extent of the Federal Reserve’s future rate cuts. The S&P 500 suffered its worst weekly percentage decline since March 2023 last week following a disappointing second-straight jobs report, although the index remains up nearly 15% for the year.
“We’re navigating an uncertain market,” said Matt Thompson, co-portfolio manager at Little Harbor Advisors. “The market is signaling elevated risk, but there is no clarity on what the key issue will be.”
With volatility already heightened, the so-called “election bump” in VIX futures for October, which also cover the November 5 vote, is notably smaller this year than in previous cycles. On Tuesday, October VIX futures were trading at 19.55, less than one point above the September contracts. The spread between contracts with the highest and lowest volatilities is barely over one volatility point. This is a stark contrast to the 2020 and 2016 elections, where the futures curve displayed gaps of 7.3 and 3.4 points, respectively, according to Reuters’ analysis of LSEG data.
Are There More Speed Bumps Ahead?
Investors have been keeping a close eye on the VIX in recent weeks, particularly after it experienced its largest-ever one-day spike on August 5. This spike was triggered by a rapid market sell-off driven by economic concerns and the unwinding of the global yen carry trade. Although the volatility subsided within days, the index has been creeping up again, reflecting recent choppiness in the markets. On Monday, Societe Generale analysts recommended that investors remain hedged over the next three to six months, citing the potential for market turbulence from unexpected economic news and geopolitical risks, including the U.S. elections, and conflicts in the Middle East and Ukraine.
However, not all market participants are equally concerned about election risks this year. Seth Hickle, managing partner at Mindset Wealth Management, highlighted that stocks have performed well under both Trump and President Joe Biden. Given that Kamala Harris’ policies are expected to align closely with Biden’s, either candidate’s victory is unlikely to pose a significant challenge to investors.
“There isn’t much uncertainty regarding potential policy changes,” Hickle stated. “The market isn’t spooked because we’ve seen these dynamics before.”
Potential Market Reactions to Tuesday’s Debate
Nonetheless, Tuesday’s debate could still provide a market jolt. The memory of the last presidential debate remains fresh, where a significant shift occurred with the introduction of a new Democratic candidate. Amy Wu Silverman, head of derivatives strategy at RBC Capital Markets, noted in a recent report that she expects the debate to contribute to some level of volatility.
Given the already tense economic environment and geopolitical landscape, traders should brace for potential short-term disruptions and consider staying hedged as they navigate the uncertain terrain ahead.
Key Takeaways:
- Volatility Concerns Rising: The VIX remains elevated ahead of the U.S. presidential election, reflecting market concerns over political and economic uncertainties.
- Limited Election Bump: Despite the election, the usual “bump” in volatility is muted compared to previous cycles.
- Economic and Geopolitical Risks: Investors should remain cautious due to potential economic surprises and geopolitical tensions.
- Potential Market Reactions: Tuesday’s debate could trigger short-term volatility, adding another layer of risk to the market outlook.
