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Volatility Update: Earnings, Elections, and the Economy

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October 20, 2016
Balance: Market volatility according to VIX is ticking slightly higher ahead of election, earnings, economy news

The first two weeks of October proved to be somewhat choppy for the financial markets as investors mulled the potential outcomes of U.S. elections and braced for a busy stretch of third-quarter corporate earnings. The future of Federal Reserve policy remains hotly debated on Wall Street as well, and it’s still unclear if and when officials may raise rates. The myriad of uncertainties seems to be giving measures of market volatility a modest lift through mid-month, and all this sets up an interesting backdrop for the final 10 weeks of 2016.

VIX Gets a Lift

The CBOE Volatility Index (VIX) has been ticking higher. The recent uptick is not too surprising given that VIX tracks the expected or implied volatility priced into a strip of S&P 500 Index (SPX) options and tends to increase during times of market anxiety and uncertainty. For instance, toward the end of last week, the S&P 500 was down roughly 30 points month-to-date after suffering losses in five of October’s first 10 trading sessions. During that time, VIX advanced from 13.29 on September 30 to nearly 16. As we can see from figure 1, the volatility index rose toward one-month highs of 18 late last week.

CBOE Volatility Index, VIX

FIGURE 1: CBOE VOLATILITY INDEX TICKS HIGHER.

The VIX approached 18 a week ago. Data source: CBOE. Chart source: the TD Ameritrade thinkorswim® platform. For illustrative purposes only. Past performance does not guarantee future results.

The Three Es

The recent rise in VIX isn’t due only to the choppy action in the S&P 500. Because the volatility index tracks expected or implied volatility, it doesn’t just look at what has happened in the past, but also reflects perceptions of what might occur in the future. In today’s setting, that future is somewhat clouded by three Es: elections, earnings, and the economy.

Elections. Recall that in late June, VIX rallied to the mid-20s shortly after the British vote to leave the eurozone (the so-called “Brexit”). Global financial markets were rattled at that time when Brits defied general expectations and voted to part ways with their EU neighbors. That’s the thing about market volatility. It tends to spike following unexpected events that cloud the horizon by driving up uncertainty. For that reason, regardless of the latest polls, predictions, or juicy headlines in the tabloids, presidential elections can potentially stir up volatility before year-end if events play out differently than generally expected.

Earnings. As we noted last week, correlations are already easing heading into the third-quarter reporting season, and that trend can persist as the results unfold. According to Zacks Investment Research, analysts currently expect S&P 500 companies to post a 2.9% decline in year-over-year earnings on 1.2% higher revenues. That’s not stellar, but it’s the best so far in 2016, and positive growth is expected to return in the fourth quarter. So it’s possible that, while some companies will surely miss expectations, others might offer positive guidance for the rest of this year and into 2017. If so, the disappointments and surprises are likely to hold some sway as the results pour in during the weeks ahead.

The Economy. On the economic front, Fed officials are currently torn regarding whether to raise rates, with some members recently signaling a growing sense of urgency to do so. The next rate announcement on November 2 is less than a week before election day. Then the final meeting of 2016 is held December 13 to 14. Each data point between now and then, including jobs numbers on November 4, holds implications for Fed policy and potentially the elections as well.

Investors can expect a lot of news flow between now and year-end, including a hefty round of earnings, economic data, two Fed policy updates, and the elections. Of course, one irony with financial markets is that, although many are focused on upcoming events that are already on the calendar, major volatility spikes typically follow some random news that comes out of the blue—in other words, something totally unexpected.

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