Yesterday Was Supposed to Be About Lower Volatility

Would you have signed up for a 1.8% two-day drop in the S&P 500 (SPX) as the election results came in?  You might not have been happy about it, but given the magnitude of the political dislocation, I’m guessing that you would have been okay with that.  As I type this around noon, that’s pretty much what we have.  The difference is that we’re arriving at that point via a roller coaster ride rather than a modest, orderly selloff.  Yesterday was “socially acceptable volatility” writ large.  Today is just plain old volatility – quite a bit of it.

SPX, 3 Days, 5 Minute Candles with Annotations

Source: Interactive Brokers

Bear in mind the magnitude of the move we digested yesterday.   Suppose I told you at Tuesday’s close that the Democrats were not only going to take over the US House of Representatives, as was widely expected by prediction markets, but that they would do so in near-record numbers, while at the same time almost every contested Senate race and several gubernatorial races in key states would also go blue.  Personal opinions aside, considering that stocks rallied in late 2024-early 2025 because of a Republican sweep, it is reasonable to think that investors might not like the opposite. 

In yesterday’s piece, we picked out these three causes for the turnabout in equity index futures on Tuesday night, from sharply negative to quite positive:

1. Removal of election uncertainty
2. Foreign investors liking that President Trump got restraints
3. FOMO

We were quite dismissive of item #1, writing:

There is a certain irony in basing a rally on a reduction of uncertainty on a day when we see a move of more than two standard deviations – more than three if we include the overnight session.  There are still many issues to be resolved, particularly surrounding data centers and the growth of AI. 

Well… those issues continue to be unresolved this morning.  Poorly received results from Qualcomm (QCOM) and Advanced Micro Devices (AMD) got tech traders off on the wrong foot, and we see the Philadelphia Semiconductor Index (SOX) trading lower by more than 9%.  Hyperscalers that rallied yesterday are not helping today, though their losses are relatively minimal.  The underlying problem, though, is that if the market capitalization of tech and AI-related stocks makes up 50% or more of the SPX (depending upon how you define those terms), it is very difficult, if not impossible, for stocks to perform well.

Yesterday, we benefitted from a solid rotation not only into hyperscalers (among the largest components of SPX) but also into classic value stocks and sectors.  Today, that’s not occurring either.  Indeed, it is hard to consider today a total rout when declining stocks outpace advancing stocks by “only” about 4:1, but that ratio is far below the 9:1 or 10:1 that constitute a washout.

The real problem is with tech stocks.  The Nasdaq 100 (NDX) closed more than 10% below its all-time high, set only one month ago, on Monday.  NDX had a decent 0.7% bounce on Tuesday but only rose by 0.9% yesterday.  That is substantial underperformance when compared to SPX’s 1.6% jump, showing the deleterious effects on perceptions about tech spending.  Today, while SPX is down by a nasty 3.6%, NDX continues to underperform, down more than 5%.

Although I attributed a fair amount of yesterday’s rally to FOMO, and still do, I also think that swinging perceptions about future volatility played a big role yesterday and are doing so today.  The Cboe Volatility Index fell sharply yesterday, and as we noted:

It was reasonable to expect a dip in forward-looking volatility measures like VIX and VXN after the election.  It was not widely expected that both measures would plummet by nearly four points each. 

Four points is quite large but seems quaint when compared to today’s 8.5-point jump.  We can see that VIX has spiked at least two other times in the past month, but not to the extent we see today.  This has the hallmarks of an “I need protection and I need it NOW” mentality.

VIX, 1 Month, Hourly Candles

Source: Interactive Brokers

I believe that yesterday’s plunging VIX gave a buy signal to algorithms that utilize implied volatility and/or VIX as a signal.  Once yesterday’s rally was well in place, that led to an ongoing decline in VIX, and thus a signal for those funds to allocate more money into the market.  That created a positive feedback loop and kept a firm bid under the market all day. 

Today, however, the opposite occurred.  We started with a placid set of overnight futures that turned south quickly.  That led to a spike in VIX, and the same funds that used a falling VIX as a buy signal were now forced to sell by a rising VIX.  That’s positive feedback, but in a negative direction.

We can go on and on: the pummeling of SpaceX (SPCX) and Tesla (TSLA) after Elon Musk spent hundreds of millions of dollars on the wrong candidates in Texas; and the fact that all 11 SPX sectors are currently trading lower.  And, oh yeah, we have employment numbers tomorrow.  So I’ll leave it here.