Wall Street: Investors seek refuge amid looming market volatility

In recent times, the U.S. stock market has enjoyed a period of relative tranquility, but investors are now bracing for a potentially turbulent stretch. Factors such as political uncertainty, tech earnings, and seasonal market weakness are driving a heightened interest in portfolio protection.

The S&P 500 has seen a remarkable rise of nearly 17% this year, buoyed by excitement over advancements in artificial intelligence and a gradual cooling of inflation. This gain has been accompanied by an unprecedented period of calm, with the benchmark index experiencing 355 sessions without a daily decline of 2% or more, the longest streak since 2007.

However, the landscape shifted dramatically last week when Wall Street’s “fear gauge,” the CBOE Volatility Index (VIX), soared to its highest level since late April. This surge followed a significant selloff in technology stocks, resulting in the S&P 500’s second-largest weekly drop of 2024.

Despite a rebound in stocks on Monday, signs of growing investor concern are evident. Uncertainty looms over tech earnings, the U.S. presidential election, and even the once-unassailable artificial intelligence leader, Nvidia, which has seen a remarkable 138% increase this year. The ratio of put-to-call options reached 0.74-to-1 on Friday, the highest defensive positioning in about two months, according to Trade Alert data.

VIX futures indicate that investors are preparing for elevated volatility surrounding the U.S. presidential election. President Joe Biden’s recent withdrawal from the race, endorsing Vice-President Kamala Harris as the Democratic candidate to face Republican Donald Trump, has added to the political drama.

“We’ve seen people wake up to the fact that there’s probably volatility coming,” said Joe Tigay, portfolio manager for Rational Equity Armor Fund. However, he noted that many investors have yet to fully adjust their portfolios to protect against potential market swings.

A key trigger for market volatility could come as tech and growth companies, which have driven market gains, report their earnings. Heavyweights Tesla and Alphabet are set to release their earnings on Tuesday afternoon. Weaker-than-expected results could prompt investors to shift their money away from tech giants and into other areas of the market that have lagged this year, furthering the rotation trade that saw technology stocks fall and small caps and other laggards soar last week.

The small-company-focused Russell 2000 has surged 9% over the last 10 sessions, while the tech-heavy Nasdaq 100 has declined by 3% during the same period. This shift has been driven by rising expectations that the Federal Reserve will soon cut interest rates and the improving political fortunes of GOP presidential candidate Donald Trump, who survived an assassination attempt.

The dominance of tech stocks this year has drawn comparisons to the ill-fated dotcom boom more than two decades ago, sparking concerns that the trade is vulnerable to selloffs. Michael Thompson, co-portfolio manager at boutique investment firm Little Harbor Advisors, noted, “That mega cap-versus-everything else trade driven by the AI theme has been going on for a while. The market, in general, felt like it had been due for some mean reversion.”

Seasonality and election year jitters could be additional catalysts for market gyrations, with September and October typically being the most volatile months for U.S. stocks. The VIX averages 21.8 in October, compared to its closing level of 14.9 on Monday, and rises to 24.8 in election years, according to LSEG data dating back to 1992.

October VIX futures, which encompass the November vote, are trading at the highest level for any contract between August 2024 and January 2025. Analysts at Deutsche Bank have warned that a tighter, less predictable race would likely increase uncertainty for markets and weigh on stocks.

Online betting site PredictIt on Monday showed that a Donald Trump victory was priced at 60 cents, compared to 39 cents for a win by Harris. A major shift in the volatility regime could hurt investors who had piled into trades specifically aimed at market gyrations staying low. One of these is the so-called dispersion trade, in which investors seek to take advantage of the difference between index-level volatility and volatility in single stock options.

However, such trades are unlikely to unravel unless the VIX rises significantly above current levels. Kris Sidial, co-chief investment officer of volatility arbitrage fund the Ambrus Group, stated, “Those knock-in levels exist more so in the high 20s of VIX.”