I argued that the VIX index was too low in a July 23 Barchart article. The VIX was trading below the 16 level when I wrote:
The VIX is not too low today, but it could be tomorrow. Sentiment in stocks is like the wind, and we could be in the eye of a very volatile storm over the coming weeks and months. The best time to prepare for a storm is long before it makes landfall.
The VIX exploded in early August, and while it came back below the July 22 15.62 level in August, there is a significant potential for an even higher high over the coming weeks and months.
October can be a nasty month for stocks
October has a bad reputation for the stock market. Some of the worst market crashes, including the 1907 Bank Panic, the infamous 1929 stock market crash that ushered in the Great Depression, Black Monday in 1987, and the 2008 global financial crisis, took stock prices significantly lower in October.
Investopedia defines the “October effect” as the psychological anticipation that financial declines and stock market crashes are more likely to occur during October than any other month.
2024 is no ordinary year
As the markets are only weeks from October, many issues that can cause significant price variance face market participants. In the U.S., a highly contentious and close election will determine the policy paths for the coming years. The U.S. Fed is now following a more accommodative monetary policy approach. Globally, wars in Ukraine and the Middle East and the bifurcation of the world’s nuclear powers create a potential for surprises that could impact the stock market and markets across all asset classes. Moreover, sanctions on Russia and China could lead to a BRICS currency that challenges the U.S. dollar’s position as the world’s reserve currency.
Markets reflect the economic and geopolitical landscape, making 2024 no typical year in history.
The election results are a coin toss
The contest between Vice President Harris and former President Trump is a close race. While the Vice President has a slight lead in the polls, it remains a toss-up. While the future of foreign and domestic policies is on the ballot, taxes could have the most significant impact on the path of least resistance of stock prices. Capital gains tax rates and a proposal to tax unrealized gains on the wealthiest Americans with net worths over the $100 million level present a challenge to stocks. Even though taxing unrealized gains will impact a small percentage of the tax-paying public, it could have far-reaching trickle-down consequences as paying those taxes could require significant stock sales by wealthy founders and early investors that push prices lower, create panic, and cause a swoon in the stock market.
Conversely, lowering corporate and individual tax rates could cause a stock market rally. Therefore, uncertainty over the election results leading up to the early November contest and following if it becomes too close to call could cause elevated stock price variance. Concerns are likely to peak in the weeks before the election, during the heart of October, historically a highly volatile month for the stock market.
The world is in flames
The war in Ukraine has intensified, with Ukrainian attacks on Russian soil and increasing Russian attacks on Ukrainian cities. Moreover, NATO support for Ukraine threatens an escalation that involves Ukraine’s allies and Russia’s allies facing off if the war spreads beyond the current borders.
The ongoing war between Israel and Hamas and Hezbollah involves Iranian proxies, including the Houthis in Yemen. Iran is on the cusp of becoming a nuclear power and Israel already possesses these weapons of mass destruction. U.S. support for Israel and tacit support for Iran from Russia and China could trigger a wider conflict with the Middle East as the hub.
China continues to plan for reunification with Taiwan, which increases tensions in Asia. Moreover, North Korea has become an aggressive nuclear power in the region.
The bottom line is that many potentially dangerous areas could develop into violent conflicts over the coming months.
Buckle up, watch risk dynamics, and consider a VIX-related product as a hedge
As we learned during the 1987 stock market crash, the 2008 financial crisis, the 2020 global pandemic, and Russia’s 2022 invasion of Ukraine, surprises tend to cause the most dramatic stock market volatility. The VIX index measures the implied volatility of put and call options on S&P 500 stocks. The S&P 500 is the most diversified U.S. stock market index. Options are price insurance. Investors and traders tend to sell options during calm and bullish stock market conditions. However, they become buyers as the odds of a downside correction rise and substantial downdrafts occur.
The long-term chart of the VIX index shows that it rose to annual highs in October 1997, October 1998, and October 2008, and tends to trade at elevated levels in September and October. The all-time high, 89.53, occurred in October 2008, and a slightly lower peak, 85.47, occurred in October 2020, when the global pandemic surprised and gripped markets across all asset classes.
As a sign of volatility on the horizon, the VIX briefly rose to its third-highest level in history, 65.73, on August 5, 2024. While the volatility index has declined to the 20 level, the October effect in 2024, which is anything but a typical year, could mean another explosive move over the coming weeks.
The ProShares VIX Short-Term Futures ETF product (VIXY) is a short-term trading tool that tracks the VIX index. At around $11.83 per share, VIXY is a highly liquid product with over $136.4 million in assets under management. VIXY trades an average of over 5.55 million shares daily and charges a 0.85% management fee.
The three-month VIXY chart shows the explosive 127.7% rally from $9.89 on July 12 to $22.52 on August 5, 2024, high when the VIX reached its latest peak.
The VIXY product is only appropriate for short-term trading purposes but could be a valuable tool over the coming weeks as the stock market moves towards October in a year that is anything but ordinary. Time will tell if there is an October effect in store in 2024, but the many issues facing markets and the potential for surprises suggest we could be in for a wild ride during the coming month.
On the date of publication, Andrew Hecht did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.
