US Election-Year Volatility: How Political Uncertainty & Economic Factors Are Shaping US Stock Market

As the US approaches a critical presidential election, investors are dealing with a blend of economic uncertainty, fluctuating Federal Reserve policy, and political volatility. These dynamics are influencing the stock market, driving demand for portfolio hedging strategies, and signalling potential turbulence ahead.

The spotlight is increasingly on the impending televised debate between Democrat Kamala Harris and Republican Donald Trump, with investors observing how each candidate's policies could impact the markets. As election-related anxiety builds, market volatility is on the rise, with the Cboe Volatility Index (VIX), often referred to as Wall Street's "fear gauge," climbing to levels above its 2024 average. Hovering around 20, the VIX has exceeded its usual election-year trajectory, which typically shows an increase of 25% between July and November, according to data from Bank of America (BofA).

While political developments usually cause an uptick in volatility during election years, this year's increase in the VIX has been exacerbated by broader economic concerns. These include a potentially softening US economy and speculation surrounding the Federal Reserve's next moves on interest rates.

The S&P 500 experienced its worst weekly percentage drop since March 2023 last week, triggered by a second consecutive underwhelming jobs report. Although the index has posted gains of nearly 15% this year, recent economic data have left investors on edge. With the Federal Reserve scheduled to meet on September 17-18, market participants are speculating on the potential for further rate cuts.

The upcoming election, slated for November 5, further complicates the outlook. Traditionally, the period leading up to the election brings about a heightened level of market uncertainty. However, this year's "election bump" in October VIX futures-a common occurrence as markets prepare for election-related volatility-is smaller than in previous years. Futures contracts linked to October volatility traded at 19.47 on Tuesday, only slightly higher than the September contracts at 18.07, with a gap of just over 1 point. This contrasts sharply with the election cycles of 2020 and 2016, where the volatility gap between the highest and lowest futures contracts was 7.3 and 3.4 points, respectively.

Political uncertainty remains a significant factor for investors, but this year's election appears to be having a more subdued effect on volatility than in previous cycles. Analysts suggest that the smaller volatility gap reflects an underlying confidence in the market, despite the looming election. While the political landscape is undoubtedly in flux, the market impact has been more measured this year.

The June debates between President Joe Biden and his challengers provided a glimpse of how politics can still move markets. Biden's poor debate performance briefly buoyed expectations of a Trump victory, leading to rallies in segments of the stock market that are traditionally seen as benefiting from Trump's policies, such as smallcap stocks and energy shares. Trump's proposals, including corporate tax cuts and regulatory easing, are viewed as supportive of these sectors. However, much of that enthusiasm diminished after Harris replaced Biden as the Democratic contender and polling margins between the two candidates narrowed.

Despite the smaller election bump, investors are far from complacent. The VIX has been a key focus in recent weeks, particularly after posting its largest-ever one-day spike on August 5 during a market sell-off triggered by concerns about a weakening economy and an unwinding of the global yen carry trade. Though volatility briefly subsided, the index has crept back up as economic data and geopolitical risks have reignited concerns.

Analysts at Societe Generale have urged investors to remain cautious, recommending that portfolios remain hedged over the next three to six months. The bank's strategists highlighted potential triggers for volatility, including unforeseen economic surprises, geopolitical tensions, and the outcome of the US election. In their view, these factors could lead to market turbulence even before the election results are finalized.

On the other hand, some analysts argue that the market's relative calm in the face of the election is due to the historical resilience of stocks under both Republican and Democratic leadership.

As investors gear up for Tuesday night's debate, they will be scrutinizing the candidates' positions on a variety of issues, from fiscal policy to clean energy and corporate taxes. Trump has promised to lower corporate taxes, take a tougher stance on trade and tariffs, and decry the strength of the US dollar, which he argues has hurt the US economy. Some analysts, however, caution that Trump's policies could spur inflation and eventually boost the dollar rather than weaken it.

Meanwhile, Harris has laid out plans to raise the corporate tax rate from 21% to 28%, a move that could dampen the enthusiasm of certain sectors of the market. However, her continued focus on clean energy initiatives-an extension of Biden's policies-could provide a boost to solar and renewable energy companies, especially as they navigate the challenges posed by high US interest rates. Additionally, her push to lower drug prices could weigh on healthcare stocks, depending on how aggressively those policies are pursued.