Prior to this week, the last time the VIX index closed above 20 was in June, just ahead of Brexit. There are some who are looking at the rise in VIX ahead of Brexit and are seeing a lot of similarities to this time. Primarily, that once the election is over, much of the uncertainty surrounding the markets will dissipate and stocks can rally.
VIX vs S&P 500 - Brexit vs U.S. Election (source Bloomberg)
While the belief that most election results should reduce uncertainty, reduce volatility and help stocks is logical, the pattern this time is very different. While the S&P makes daily headlines about how many days in a row it has been down, it was actually increasing ahead of Brexit along with VIX.
There was positive momentum for stocks heading into Brexit as the market was still pricing in Central Banks that were fond of QE rather than Central Banks that are pulling back from QE or even hiking rates in the U.S. Another key difference is that the immediate impact of Brexit on the Global economy seemed minimal. While scenarios could be built that would hurt the global economy, the more realistic impact was that it would be a 'zero sum' game with the U.K. losing something that other countries gained. It will be far harder for global markets to ignore any big surprise results in the U.S.
So the stock market was behaving differently than before Brexit, Central Banks were perceived as behaving differently and it is far easier to ignore economic uncertainty in the U.K. than in the U.S. Add to that mix the fact that global bonds yields have been rising and credit spreads have been widening with some large High Yield ETFs (HYG and JNK) and a large Investment Grade ETF (LQD) all experiencing significant outflows in the past weeks (I am yet to see data confirming large IG outflows from mutual funds, but it is something I am watching closely). I still like leveraged loan funds over high yield funds (here and here)
So I believe the stock market is set-up differently than ahead of Brexit, but is that enough to cause VIX to spike from already 'elevated' levels?
While VIX is 'elevated' compared to the lows seen for much of September and August of this year, it is below levels reached in the immediate aftermath of Brexit and February and is far below its spike in August of 2015. So while VIX is high relative to the most recent data, it has room to move higher. The fact that VIX rose this week even while ETPs like UVXY, VXX and TVXY were seeing their shares outstanding drop, indicates that there is strong demand for hedges (and that some of the demand might be from those who sold volatility expecting a smooth run up to the elections).
I can see both sides of the argument but I think the current situation is very different that Brexit and would not be too quick to bet against VIX rising further and stocks falling further over the coming week (almost anything is possible in overnight trading the night of the election when algos will be out in full force and it will be far easier to react to price than any other form of information).
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