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Market Watch: Investors Seek Protection Amidst Political Uncertainty and Earnings Season
Investors are increasingly looking for ways to safeguard their portfolios as the U.S. stock market faces potential turbulence stemming from political uncertainty, upcoming tech earnings, and typical seasonal fluctuations.
The S&P 500 has surged nearly 17% this year, buoyed by enthusiasm over advancements in artificial intelligence and a gradual decrease in inflation. Notably, the market has experienced an unprecedented period of stability, going 355 trading sessions without a daily decline of 2% or more—the longest such streak since 2007.
However, signs of this tranquility may soon be challenged. Elevated levels in the Cboe Volatility Index (VIX), often referred to as Wall Street’s fear gauge, suggest that investors are bracing for potential shifts. The VIX recently spiked to its highest point since late April, triggered by a selloff in technology stocks that resulted in the S&P 500’s second-largest weekly drop of 2024.
Despite a bounce back in stock prices on Monday, apprehension is palpable among investors regarding various factors, including upcoming earnings reports from major tech firms and unfolding developments in the U.S. presidential election. Even Nvidia, a standout performer with a 138% year-to-date increase, is under scrutiny, as evidenced by a recent uptick in the ratio of put options to call options, which reached 0.74-to-1, reflecting heightened caution in trading strategies.
Adding to investor unease is the current political landscape. In a notable shift, President Joe Biden suspended his reelection campaign amid mounting pressure within the Democratic Party and endorsed Vice President Kamala Harris as the presidential nominee to face off against Donald Trump in the November elections.
Joe Tigay, portfolio manager for the Rational Equity Armor Fund, commented, “There’s a growing recognition that volatility could be on the horizon. Yet, it seems that many investors haven’t fully adjusted their strategies to account for this potential shift.”
Tech earnings reports, beginning with Tesla and Alphabet this Tuesday, may serve as a pivotal moment for market volatility. Should these companies report results below expectations, it could lead to a massive reallocation of funds from technology stocks towards sectors that have underperformed this year, fueling a rotation trade that recently saw small-cap stocks outperform technology shares.
The small-cap focused Russell 2000 index has risen 9% over the last ten trading days, while the technology-heavy Nasdaq has fallen by 3% in the same timeframe. This shift has been influenced by rising speculations regarding an impending interest rate cut by the Federal Reserve, as well as the revitalized prospects of Trump’s presidential bid following an assassination attempt.
The dominance of technology stocks this year has raised concerns about market stability, drawing parallels to the dotcom bubble of the early 2000s. Michael Thompson, co-portfolio manager at Little Harbor Advisors, noted, “The prevailing trend of mega-cap stocks outperforming everything else has been sustained for some time. It feels like the market is due for some mean reversion.”
Seasonal factors and election-year dynamics may also contribute to increased volatility. Historically, September and October are recognized as the most turbulent months for U.S. equities, with the VIX averaging 21.8 in October, significantly higher than its current level of 14.9. This volatility tends to spike even more in election years, averaging 24.8.
Futures for October, which coincide with the presidential election, are trading at the highest levels for contracts running from August 2024 to January 2025. Analysts at Deutsche Bank have indicated that a tightly contested election would likely amplify uncertainty in the markets and exert downward pressure on equities.
The online betting platform PredictIt currently shows a 60% probability of a Trump victory, contrasting with a 39% chance for Harris, which underscores the unpredictable climate leading up to the election.
A significant shift in market volatility could pose risks for investors who have positioned themselves for a continuation of low market swings. One such investment strategy is the dispersion trade, targeting discrepancies between overall market volatility and individual stock options volatility.
However, experts suggest that these trades are unlikely to unwind unless the VIX moves significantly higher. Kris Sidial, co-chief investment officer of volatility arbitrage fund Ambrus Group, stated, “The thresholds for these strategies are typically encountered in the high 20s range for the VIX.”
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