Historical trading patterns shift as investors respond to the pandemic and upcoming election

David Joy – Chief Market Strategist, Ameriprise Financial
Weekly markets commentary — Aug. 10, 2020

Despite the fact that the economic stimulus negotiations in Washington broke down ahead of the weekend, equity futures are fractionally higher ahead of the start of Monday trading. Through executive order, the president has attempted to fill the gap by extending unemployment benefits, suspending payroll taxes, extending lower student loan interest and the moratorium on evictions. Some are questioning the legal authority of the president’s actions, but most agree that the orders are collectively no substitute for a more sizeable and comprehensive stimulus package. Both sides in the negotiations have expressed a willingness to keep trying, but a higher stock market will not lend renewed urgency to crafting a deal.

Historically, August is a difficult month for stocks. Over the past fifteen years the average return for U.S. stocks during the month was -0.4 percent. August also happens to be the most volatile month historically. But so far this year neither of those two things is occurring. The S&P 500® index is higher by 2.5 percent after the first full week, and the VIX index of implied volatility has fallen below its 200-day moving average to its lowest level since February 21.

Why are investors seeing a shift in traditional market patterns?  

Why these early reversals in the historical pattern are happening can likely be explained by the upending of the market’s internal clock by the pandemic and subsequent response. The timing of the fiscal and monetary stimulus in March and beyond has resulted in a market and economic recovery that has extended into August, in part due to the promise of a fourth round of stimulus. Positive early results in the development of a vaccine and better than expected second quarter operating results have also helped.

But that has now brought us to a potentially important inflection point for stocks. Evidence that economic activity has recently plateaued, as the scourge of the virus continues, argues for additional fiscal support from Washington. The longer a comprehensive fiscal package remains elusive, the more vulnerable will be a market with valuations that are stretched. Given the fact that this is an election year it is a safe bet that a deal still gets done. The political calculus of who will get the credit for success or the blame for failure is too great.

What can investors expect with 85 days until the election?

There are now 85 days to go before the election. Historically, market volatility begins to rise about 45 days ahead, or roughly three weeks into September, before peaking one week before the election. But, as is the case this year, if an incumbent is in the race the rise in volatility ahead of the election tends to be more muted than otherwise. Stocks also tend to perform better ahead of an election if an incumbent is in the race. As for returns, August and September are historically weak, and election years are no exception. October returns tend to be strong in non-election years, but less so in election years, although still positive.

These are historical averages and it remains to be seen if they hold true this year. For now, the forward curve of the VIX indicates that it will, at least for volatility. The spot VIX is currently trading at 22.9. However, the October contract is trading at 30.4, after which it declines to 27.9 by year-end. Investor anticipation of a rise in volatility into the election has also resulted recently in strong flows into long volatility vehicles. Market moves also tend to be exaggerated in the second half of August, as vacations ahead of Labor Day historically leave trading volumes thin. But with so many already working remotely, that may not be the case this year.

This week’s economic calendar will provide further insight into the extent of any moderation in activity with the July reports for retail sales and industrial production. Both are expected to have moderated relative to June. Preliminary consumer sentiment for August is also expected to remain soft after a July decline reversed a two-month increase in May and June.