Insights
September 2020 Market Perspective
Thursday, October 8, 2020
Typically, presidential election years feature below-average equity
market volatility. Volatility levels tend to decline from the first half to the
second half of election years, with volatility levels in the first half more
similar to non-election years. Needless to say, 2020 has not been typical.
Moreover, volatility futures markets are indicating an expectation that
abnormal volatility levels will continue over the remainder of the year. How
should investors prepare for a potentially volatile fourth quarter?
Figure 1 illustrates the counter intuitive pattern of typical presidential
election years. On average, presidential election years experience their
highest volatility months in the first four months of the year, followed by
declining volatility in the summer months and rising volatility toward
year-end, though volatility levels in the last three months have tended to stay
below average in most election years. Of course, every year is different and
2008 stands out as a year that did not follow the typical election year
pattern. However, the extreme volatility levels in the final months of 2008
were driven far more by the Great Financial Crisis than by election year
dynamics. To eliminate the impact of the Great Financial Crisis on the
volatility pattern of election years, 2008 was removed from the dataset
represented by the light blue bars.
Source: Bloomberg, L.P.
One aspect of volatility levels in 2020 has been consistent with the
typical pattern of presidential election years: declining volatility in the
summer months followed by an increase in September (see Figure 3, below).
Interestingly, volatility this August was below average, even for an election
year, while September volatility was above average, relative to both election
years and non-election years. The well-above-average volatility of September
and the recent shape of the volatility futures curve suggest that investors
should be prepared for a fourth quarter that is significantly different than a typical
election year. At the end of September 2020, month-end expirations of the Cboe®
Volatility Index (the VIX®) futures contracts,
reflected expectations of above-average volatility for the remainder of the
year.
Source: Bloomberg, L.P.
The year 2000 stands out as a year in which the presidential election
had an impact on equity market volatility. It may be an apt comparison to this
year as expectations of elevated volatility in the fourth quarter may be
associated with the possibility of an uncertain election outcome rather than
the market’s anticipated response to a clear victory by one candidate. Weeks
after election day, the election of 2000 was ultimately decided by a Supreme
Court decision that resulted in Florida’s electoral college votes being
allocated to George W. Bush. Bush’s opponent, Al Gore, conceded on December 13,
2000. With the COVID-19 pandemic leading to expanded vote-by-mail options, some
investors anticipate greater-than-usual potential for a delay in this year’s
election results.
Source: Bloomberg, L.P.
In addition to elevated volatility, the fourth quarter of 2000 also
featured a decline of 7.82% for the S&P 500® Index, with a
November return of -7.88% and a slight loss and a slight gain for the months of
October and December, respectively.
Will election results, or lack thereof, lead to higher equity market
volatility? As always, Gateway will take a wait-and-see approach rather than
try to anticipate the outcome of events and market direction. We believe it is
prudent for long-term investors to be prepared to stay invested through a wide
range of possible outcomes. Our risk-first approach is focused on keeping the
risk profiles of our strategies as consistent as possible. A potential benefit
of the elevated volatility that has existed recently is that it has resulted in
increased cash flow potential for the option-writing components of our
strategies: higher volatility results in higher option premiums and increased
cash flow from option writing. Higher cash flow can result in attractive equity
market participation in the event that market volatility is expressed to the
upside, at the same time, higher cash flow can result in significant downside
protection if volatility is associated with a downside event. As the remainder of 2020 unfolds, Gateway’s
investment team will be vigilantly monitoring option markets for opportunities to
enhance cash flow in an effort to help our investors meet their long-term
goals.
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September 2020 Market Perspective
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