Rising Volatility Ahead of Key Election
U.S. Election Adds to Stock Market Volatility Amid Economic Uncertainty
The Debate Influence on the Market
The U.S. stock market is facing a perfect storm of volatility driven by several factors, including economic concerns, Federal Reserve policy shifts, and the upcoming U.S. presidential election. Investors are increasingly turning to portfolio hedging as the risks to the stock rally grow.
Rising Volatility Ahead of Key Election
The Cboe Volatility Index (VIX), a key measure of stock market volatility, has risen to around 20, compared to its 2024 average of 14.8. This uptick in volatility comes as investors anticipate Tuesday's televised debate between Democrat Kamala Harris and Republican Donald Trump. Historically, the VIX increases by around 25% between July and November during election years, with market participants focusing on the implications of candidates' policy proposals.
However, this year’s volatility stems from more than just political concerns. Investors are also grappling with uncertainty surrounding the U.S. economy and how aggressively the Federal Reserve will cut interest rates to prevent a recession. Last week's underwhelming jobs report, combined with manufacturing weakness, added to the market's caution.
Key Insights from VIX Futures
The "election bump" in October VIX futures — encompassing the November 5 election — is smaller than in previous years. On Tuesday, October futures traded at 19.47, just over 1 point higher than September contracts. In comparison, the 2020 and 2016 election cycles saw significantly larger gaps of 7.3 and 3.4 points, respectively, in volatility between different months.
Still, the upcoming election has already had an impact on the markets. A June debate gave a boost to Trump's odds and led to a rally in small-cap and energy stocks, sectors expected to benefit from Trump’s policies. However, as Harris replaced Biden as the Democratic candidate, the "Trump trade" began to cool, with polls showing the race is neck-and-neck.
Investor Sentiment and Fed's Role
“This is an uncertain market,” said Matt Thompson, co-portfolio manager at Little Harbor Advisors. “The market knows risk is elevated, but it’s unclear what the specific problem will be.”
The rise in volatility this year is not only election-driven. The S&P 500 posted its worst weekly percentage loss since March 2023 last week, even though it's still up by nearly 15% for the year. Investors are anxiously awaiting the Fed's meeting on Sept. 17-18, which could bring clarity on how much the Fed will cut rates to support the economy.
Diverging Election Risks
Not all investors are equally concerned about the political risk posed by the election. Seth Hickle, managing partner at Mindset Wealth Management, noted that stocks have performed well under both Trump and Biden, and the policies expected from Harris are likely to follow Biden's administration closely.
“We don’t have much uncertainty about what will change,” Hickle said. “I don’t think it really spooks the market because we’ve already been through it.”
Focus on Policy Proposals
Tuesday's debate will offer investors insights into the candidates' positions on critical policy issues, including tax policy, trade, and clean energy initiatives. Trump has pledged to lower corporate taxes and take a tougher stance on trade. In contrast, Harris has proposed increasing the corporate tax rate from 21% to 28%, which could impact large corporations.
Economic Risks and Election Trades
Strategists at Societe Generale advised investors to stay hedged, citing potential volatility from economic surprises and geopolitical factors. With the Federal Reserve's rate cuts expected to be a key driver of market behavior, some investors may limit their election-related trades until clearer economic data emerges.
Conclusion
While the U.S. election is undoubtedly contributing to market volatility, it is not the only factor weighing on investors' minds. Economic concerns, inflation fears, and Fed policy shifts are also playing a major role. As the election approaches, volatility is expected to rise, but the market will likely remain focused on broader economic trends in the coming months.