The 2020s have played host to a degree of market volatility that hasn’t been seen since the global financial crisis of 2008. As geopolitical tensions continue to boil over and a tumultuous US presidential election looms, could we be heading for the perfect storm as far as the Volatility Index (VIX) is concerned?
Early indications suggest that investors are bracing themselves for an unpredictable year for stocks, and newly-listed volatility futures contracts anticipate a stronger level of erratic behavior around the time of the US presidential election in November.
October futures on the Cboe Volatility Index have been trading at an exceptionally high 20.65, representing a 3.2-point increase on September futures. This gap represents a larger increase than at any other consecutive months throughout the 2024 VIX curve.
Market turbulence has hit hard in recent years. The shock of the COVID-19 pandemic and Russia’s invasion of Ukraine have accelerated a trend reversal in globalization while heavily impacting monetary markets, energy, and supply chains.
Alongside this, growing tensions between the United States and China have rumbled on while the worrying escalation of conflict in the Middle East has carried a severe humanitarian toll as well as widespread concerns over global economic performance.
The Volatility Index, which actively monitors expected volatility across financial markets, has delivered considerably higher averages since 2020 than throughout the 2010s.
To accompany this, the World Uncertainty Index, which looks at the prevalence of the word ‘uncertain’ in analyst reports, has been trending upwards since the beginning of the millennium and jumped to an unprecedented peak in 2020 in the wake of the pandemic. This underlines the difficult conditions that hampered the decisions of institutions across global markets in recent years.
The Adverse Impact of Global Events on Markets
As global events such as the rise of geopolitical uncertainty and the upcoming US presidential election continue to create a confounding effect on markets, it’s worth looking at exactly how such scenarios breed uncertainty throughout Wall Street and beyond:
- Changing Risk Perceptions:On a fundamental level, geopolitical events can adversely impact trader sentiment and alter their risk perception. Whether it’s the return of conflict or a political concern, this uncertainty can induce fear, resulting in stock sell-offs.
- Economic Uncertainty: Geopolitical events can have a significant impact on global economies, and the imposition of tariffs can lead to increases in production costs and supply chain disruptions–leading to a negative impact on the reporting of affected industries and firms.
- Forecasting Troubles: Uncertainty makes forecasting far more troublesome for analysts. Traders will be less inclined to execute investment decisions which will lead to smaller volumes until more clarity returns to the market.
- Searching for Stability: Likewise, geopolitical uncertainty can adversely impact financial stability, with governments likely to impose more financial restrictions and limits to cross-border credit, trade, and investment–triggering capital outflows in the process.
Measuring the Impact of the US Presidential Election
So, how alert should investors be to volatility in the build-up to the US presidential election in November? The event itself is set to be a carbon copy of the Joe Biden vs Donald Trump bout of 2020, with forecasters expecting a particularly close-run contest.
Historically, the VIX Index trades higher on the election day in comparison to readings taken in the 60 days before the election itself. However, this trend isn’t always a guarantee for volatility, and as an event that occurs every four years, it can be difficult for modern metrics to generate any rhyme or reason for election uncertainty.
There are, however, some notable historical precedents that we can observe. For instance, the 2008 election cycle saw the VIX almost double over the two months leading up to the November election and even after the event.
For the 2000 election cycle, the VIX rose in the days leading up to the election and continued advancing as the reality of the upcoming policy changes hit home for investors. However, it’s also worth highlighting that the 2000 and 2008 elections coincided with widespread financial downturns.
As we can see from the past 20 years of the index, volatility has been unsurprisingly at its highest around periods of severe economic downturns.
While the VIX has trended consistently higher than its average throughout the 2010s, evidence suggests that the 2024 election is going to bring more volatility than either of the past two election days.
With Cboe October futures growing in price at a consistent pace, the gap between that and the month prior is now wider than both the 2016 and 2020 election cycles, according to data.
Given the tumultuous campaigns experienced in recent years as Democrats and Republicans battle it out in an increasingly polarized political landscape, it’s clear that there’s a lot at stake for Wall Street and beyond as decision day edges closer. But could this offer an unlikely opportunity to institutional investors in the months ahead?
Finding Opportunities Amid Uncertainty
During periods of high volatility, resourceful institutions can find new opportunities via algorithmic trading strategies.
As volatility generally decreases levels of liquidity, it can be observed that traders look to more bespoke levels of algo trading that can incorporate high touch and portfolio trading.
“As market volatility increases, we find clients tend to specify more algo parameters on an order level i.e., ‘offsets to benchmark’, ‘would levels’ and ‘smart scaling’,” explains Chris McConville, global head of execution services and trading at Kepler Cheuvreux Execution Services (KCx). “We also see an increase in customized algo usage. In more recent situations where market volatility has increased, we saw an increase in demand for agency blocks.”
In a more unpredictable landscape, quality in-depth analysis like 26 Degrees Global Markets’ algo execution data are essential and should be sourced not only from propriety systems but also through independent vendor software.
“AI has significantly improved the efficiency of data processing and analysis, enabling faster assessment of large datasets crucial for algo trading strategies,” highlights Andrew Bradshaw, Global Head of Prime – Hedge Funds at 26 Degrees Global Markets. “This extends to machine learning algorithms that continuously learn from new data and optimize trading strategies for changing market conditions, all while minimizing human bias in the investment process.”
Of course, algo high-frequency trading can also be risky during periods of volatility. Algorithms can often react instantly to market conditions, and this means that volatile landscapes can their bid-ask spreads to prevent instances where they’re forced to take trading positions. They can also prospectively stop trading altogether, which could leave institutions high and dry as volatility increases.
Preparing for Volatility
Although US election days are generally prone to short-term volatility, 2024 may see more investors become caught up in more uncertain market conditions. This, accompanied by the escalation of geopolitical conflict and rising tensions, could amount to a perfect storm on Wall Street.
While more risk-averse traders could see this as a call to move into safe-haven assets, risk-taking institutions could use algorithmic trading to take advantage of volatility as it rapidly rallies and declines. However, with unpredictability reigning supreme, it’s essential that market intelligence is followed and algorithms are well-calibrated throughout what could become a challenging year.