October during an election year isn’t always bullish for the stock market. In fact, according to the Stock Trader’s Almanac, the average change in the S&P 500 is -0.7%. Perhaps election uncertainty serves to keep rally attempts in check? For whatever reason, equities often see lackluster action in the month before voters go to the polls. But this year, it’s not just about the elections. Earnings could be an important force driving market volatility as the numbers unfold in the weeks ahead.
VIX Ticks Higher
The first week of October had its ups and downs, and the CBOE Volatility Index (VIX) saw choppy action as well. The VIX, which tracks the expected or implied volatility priced into a strip of S&P 500 Index options, finished September at 13.29 – a far cry from the 20+ readings seen roughly a month ago. It was near 14 heading into the final hours of trading on Friday and has been climbing modestly since briefly dipping below 12 in late September.
The decline in VIX from mid-September to mid-October seems to suggest investor risk perceptions on Wall Street were easing during that one-month period. After all, the index is often called the market’s “fear gauge” because it tends to spike during periods of increasing investor angst, anxiety, and pessimism. For instance, the spike to the mid-20s in June of this year was triggered by concerns about Brexit.
But since the lows during late summer and early September we’ve seen a spike and general trend higher in volatility. This is consistent with the historical pattern heading into elections, which of course overlaps third quarter earnings reports.
A Mixed-Up World
VIX isn’t the only indicator trending lower since mid-June. The CBOE S&P 500 Implied Correlation Index, listed under the ticker JCJ, is designed to measure the amount of co-movement or correlation between individual S&P 500 stocks. When it moves higher, the index suggests the correlations are increasing and stocks are tending to move in a similar manner. This typically happens when global macro events are driving equities, as they did in June.
The recent decline in correlations is happening just before the third-quarter earnings reporting season. Many of the big financial names are due to release results in coming days, with the floodgates on reports really open wide in the middle of next week. Analysts currently expect lackluster overall results, with S&P 500 companies showing a 3% decline in overall earnings on 1% higher revenues, according to Zacks Investment Research.
Yet, in a typical earnings reporting period, some companies top estimates, others match expectations, and some disappoint. This causes share prices of some companies to react favorably and others negatively as the results pour in. In other words, the trend of mixed trading and falling correlations could persist through the earnings season. That, in turn, would likely trump election uncertainty in October 2016.
— Steve Smith