S&P 500: Watch Out for Tactical Buy Signals as Election Volatility Peaks
Halloween is not the only thing spooking investors right now. Today’s highly anticipated employment report, a busy week of earnings that includes a handful of the Magnificent Seven names, rising yields as we discussed last week, and of course, next week’s U.S. election are all contributing to building angst in the market — not to mention a Federal Open Market Committee (FOMC) meeting that wraps up on Thursday.
The degree of fear in the market can be measured by the CBOE Volatility Index, more commonly known as the VIX or “fear-gauge.” This index represents implied 30-day volatility derived from the aggregate values of a weighted basket of S&P 500 puts and calls over a range of strike prices. Generally, a rising VIX is associated with increased fear and uncertainty in the marketplace and falling stock prices, and vice versa for a declining VIX. The VIX is also used as a sentiment gauge and to hedge equity positions.
As highlighted below, the VIX has shifted notably higher over the last several months. The low-volatility regime represented by low-teen VIX readings in the first half of the year appears to be over as volatility recently reverted back to its longer-term average (as it tends to do). This shift higher suggests investors should prepare for a more “normal” volatility backdrop ahead.
However, we may need to wait until after Election Day for volatility to normalize as the VIX futures curve points to potential elevated near-term turbulence for stocks. (Seasonality trends agree as the VIX tends to peak near the election.) The middle panel of the chart below depicts the spread between the spot VIX and the six-month VIX futures contract.
The positive reading, known as backwardation, reflects elevated hedging demand due to increased uncertainty in the market over the near term. Backwardation is rare, occurring only about 20% of the time, and is usually short-lived with major spikes often overlapping with market bottoms.
What does this mean for stocks? As highlighted in the bottom panel, the current VIX reading equates to a potential S&P 500 range of 5,386 to 6,111 over the next 30 days. Coincidentally, the lower end of the indicated range lines up with a key support area (5,355–5,403) for the broader market, marked respectively by the 200-day moving average (dma) and September lows.
Source: LPL Research; Bloomberg 10/31/24
S&P 500 Performance Into and Out of Election Day (1928–2020)
Source: LPL Research, Bloomberg 10/31/24
If volatility does pick up and stocks decline, seasonal trends (and of course the fact we are in a strong bull market) suggest investors should buy the dip. The S&P 500 is about to wrap up the widely discussed “Sell in May” period with an impressive 15% gain as of October 30. For context, this six-month stretch spanning from May through October has been the weakest for the index, generating an average gain of only 1.7% since 1950.
History implies the upside momentum could continue as stocks enter their best six-month stretch starting today. From November through April, the S&P 500 has generated an average return of 7.2%. And even during post-election years, returns have been above average at 5.3%. Furthermore, the S&P 500 has finished higher during this timeframe 77% of the time, marking the highest positivity rate across all other six-month periods.
Source: LPL Research, Bloomberg 10/31/24
Summary
There is no shortage of near-term event risk over the coming weeks. Implied volatility levels suggest investors should buckle up for a potentially bumpier ride ahead, especially more turbulent than the low volatility regime experienced in the first half of this year. Rising yields could further complicate the macro backdrop on a near-term basis, especially with the 10-year Treasury trading near key resistance at 4.30%.
Technically, equity market momentum has stalled as the broader market approaches resistance from the upper end of its longer-term rising price channel, a logical spot for a pullback or pause in this rally. The good news is that selling pressure in stocks could provide a tactical opportunity to buy the dip as the longer-term bull market remains alive and well, supported by solid fundamentals and a surprisingly resilient economy.
