How the Presidential Election is Influencing Stock Market Volatility

As the presidential election approaches, stock market investors are grappling with increased volatility, which is vividly represented by the VIX, the CBOE Volatility Index. While the S&P 500 Index (SPX) has recently reached an all-time high, the underlying market dynamics depict a more nuanced story characterized by fluctuating market breadth and mixed signals.

S&P 500 Index Surges Amid Election Uncertainty

The S&P 500 Index has notably shrugged off unfavorable sentiment from late September and successfully hit a new record high. Despite this upward momentum, market breadth has not entirely mirrored this bullish trend, presenting a divergence that could signify underlying weakness. Currently, support is identified at the 5,670 mark; a close below this level would raise red flags for investors. The target for the index remains the +4 “modified Bollinger Band” (mBB), which is climbing and now situated around 5,840.

The bullish sentiment is underscored by the McMillan Volatility Band (MVB) buy signal, which remains active and is intact as long as SPX continues its upward trajectory towards the +4 Band. However, caution is warranted as the equity-only put-call ratios are continuing their decline, suggesting that put buying is lacking even while call buying flourishes. This imbalance has caused the ratios to approach overbought territory but will only yield sell signals once they reverse course sustainably.

Market Breadth Shows Warning Signs

Market breadth has been relatively weak, with indicators such as the breadth oscillator generating sell signals for both “stocks only” and NYSE breadth oscillators. Although NYSE breadth has demonstrated slightly more strength, the modest positive breadth recorded over the last two trading days—despite SPX’s rise—warns of potential instability. The cumulative volume breadth (CVB) continues to forge new all-time highs, affirming the strength of the SPX’s climb without providing evidence of negative divergence.

Moreover, new highs on the NYSE have consistently outpaced new lows, maintaining a bullish outlook unless new lows surpass new highs for two consecutive days.

VIX Showcases Increasing Volatility

Amidst these fluctuations, the VIX continues its ascent, largely influenced by what has been termed the “election bump.” This phenomenon arises as traders anticipate heightened volatility surrounding the impending election. Notably, while the trend of VIX sell signals persists—due to current levels being significantly above its 200-day moving average (MA)—the rise in VIX places it in a “spiking” mode. For a confirmed buy signal to unfold, VIX must close at least three points below its latest high of 23.14, reached on October 8.

The structure of volatility derivatives indicates a predominantly bullish sentiment for stocks. The term structures of VIX futures are upward-sloping, with October and November VIX futures showing elevated prices due to expected post-election volatility.

Understanding the Election’s Distortion on Volatility Indicators

The term “election bump” refers to the skewed pricing dynamics in the term structure of VIX futures. Currently, October VIX futures are trading at a premium relative to their November and December counterparts, as they are influenced by SPX options set to expire just after the election on November 15. Heightened volatility surrounding significant events typically drives up the prices of options linked to those events, creating a pronounced effect in the near term.

Interestingly, the correlation between the election and stock market movements is not as pronounced historically as market perceptions suggest. Until recently, the “election bump” had minimal impact on VIX values, but as election day nears, heightened anxiety among investors regarding potential outcomes has introduced volatility into the market landscape.

This “election bump” is further visible in CBOE Volatility Indices (VX00), where the gap between nine-day VIX (VIX9D) and VIX prices has grown significant. The current VIX is markedly higher than VIX9D while aligning more closely with the 90-day VIX (VIX3M), thereby elucidating the impact of this increased market anxiety.

Concluding Remarks

As the presidential election inches closer, investors will need to navigate a period characterized by unpredictable market volatility. The combination of a resilient S&P 500, mixed signals in market breadth, and increasing VIX levels highlight the delicate balance at play. With the potential for continued spikes in volatility driven by election-related factors, it is prudent for investors to stay informed and adjust strategies accordingly to manage risk and capitalize on market movements.