11-12-24: What the Post-Election Collapse in Volatility Means

by Ivan Martchev

November 12, 2024

A clear win by Donald Trump is a definite positive for the markets, as the feared “hung election” scenario was swiftly priced out of the market. You can see that in collapsing implied volatility in index options (see chart) gapping down, and the surge in major indexes. There is something called the “Trump trade,” where industrials, financials and small caps outperform, while there is rotation out of technology.

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

I expect more gains going forward, with the overall stock market appreciating in November, December and even into January. Over the last 100 years, those are three of the strongest market months of the year.

What would be a good new target for the S&P 500? In a world where geopolitics does not mess up this positive setup, I can see it going all the way to 6,500 by the end of the year. This puts the 666 low of the Great Financial Crisis in perspective – reflecting an almost 10-fold gain since it was set in March 2009.

I expect the Russell 2000 index to double the S&P 500’s return by the end of the year. The Russell is a weird index, in the sense that it can under-perform the S&P 500 for a long time, as it has recently, and then when the fundamentals change for the better it can dramatically surge ahead, as it is doing now.

The way volatility is now being priced out of index options means that money is coming from the sidelines into the stock market. More allocation towards equities in times of collapsing volatility is an old institutional trick. The VIX closed a hair below 15 on Friday. By the end of the year, if geopolitical situations stay reasonably contained, I can see it going to the lows of the year – under 12.

While U.S. stock benchmarks were surging, there was notable selling into strength on both Wednesday and Friday in Europe, which tells you that a re-calibrating of the US-EU trade relationship is coming. There was also some selling in Japan. China is another story, but their stock markets can be manipulated, for lack of a better term, and have never appropriately reflected China’s GDP growth in the past 20 years.

After January, I expect volatility to pick up as President Trump gets going on his agenda, with tax changes coming and a renewal of trade wars, where President Trump does have unfinished business from his first term. His trade policy was put on hold during COVID but is sure to go into turbo-drive in ‘25.

I have known for over 20 years that the U.S. has been taken advantage of by the trade policies of trading partners in Asia and Europe. If it takes a more abrasive individual, like Donald Trump, to stop that long-term disastrous trend, all power to him, as the previous approach of kicking the can down the road was leading no place good. The possible involvement of Elon Musk in the new Trump administration is also interesting, as he is a brilliant businessman and cost cutter and surely will have innovative ways to reverse the bizarre situation of surging tax revenues being outpaced by a bigger surge in government spending.

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

If a picture is worth a 1,000 words, the chart above, from a well-known financial planning firm, fulfills that old maxim. Over the past decade, U.S. federal government tax revenues have increased by 63% while spending has increased 93%. The surge in government spending during COVID was necessary to avoid a Second Great Depression, but there are disturbing spending trends here that have no relation to COVID.

The new Trump administration needs to converge those two lines over time.

Chairman Powell Held Quite a Unique FOMC Press Conference

The words, “no”, “no” and “not permitted under the law” will surely stick out in FOMC history as Fed Chair Powell elaborated rather bluntly that he will not resign, and President-elect Trump cannot remove him because he wants lower interest rates. While I support Donald Trump’s fiscal agenda, as we know it today, I think he needs to stay out of the Federal Reserve’s business – as much as I find issues with some of the things Powell has done. If Powell leaves in 2026 without a recession on his watch after a historic monetary tightening cycle, he will be forgiven many mistakes when the history of his term is finalized.

In the meantime, expect a few more interest rate cuts before we know what the Trump administration is actually going to do. Suffice it to say, Trump 2.0 should be rather unorthodox given his track record and how he vowed to be different this time. One thing you can say about Trump is that he tried to do exactly what he promised in his first term, but was hamstrung by COVID in his final year. I think he will try to do exactly what he promised now, but I am not yet sure what all the details of that plan are right now.