Analysis: No White House result? Wall Street's 'fear gauge' shows less panic

NEW YORK (Reuters) - Going into Election Day, market participants fretted about possibly waking up to an unclear result. But with that outcome realized, they seemed remarkably calm about not knowing the winner of the U.S. presidential race.

FILE PHOTO: A statue of George Washington stands as Federal Hall across Wall Street from the New York Stock Exchange in Manhattan in New York City, New York, U.S., October 26, 2020. REUTERS/Mike Segar/File Photo/File Photo

As it turns out, the likelihood of continued gridlock on Capitol Hill provided some solace.

Wall Street’s “fear gauge” plummeted as U.S. stocks surged on Wednesday, which investors attributed to near-certainty of a divided Congress. Republicans appeared likely to maintain control of the Senate, diminishing the prospect of a Democratic sweep in Washington.

Several analysts had pointed to a drawn-out election process - including the possibility of a challenge before the Supreme Court - as a dire scenario for U.S. equities. Though that risk is not off the table, the congressional outcomes have removed much uncertainty, investors said. A divided Congress would counterbalance the White House’s agenda whether Republican President Donald Trump or Democrat Joe Biden won the election, they said. In particular, it would reduce the likelihood of corporate tax hikes and increased regulation.

“Regardless of where the presidential slot goes, the market has gained confidence in that trajectory,” said Eric Metz, president and chief investment officer at SpiderRock Advisors.

The Cboe Volatility Index ended 5.98 points lower at 29.57, its biggest one-day decline since April 2. VIX futures also broadly fell, though by more modest amounts than the index.

Having the election in the rear-view mirror also paved the way for a lower VIX, investors said, given an array of anxieties - including civil unrest after Election Day - had already been priced in.

“We’re not seeing an ‘all-clear,’ but maybe some of those worst-case scenarios are off the table,” said Matt Thompson, managing partner at Thompson Capital Management.

Given recent history, market participants had geared up for extreme election-related volatility. In 2016, the VIX jumped overnight after Trump’s surprise victory. However, the VIX plummeted the following day as U.S. stocks rallied, reversing course from a late-night plunge in futures.

The VIX posted similar declines on Wednesday. Still, it remains well above its long-term average near 20. December VIX futures were trading above other listed contracts, suggesting concerns about risks into early 2021, such as a resurgence in COVID-19 cases.

“Volatility hasn’t disappeared,” said Stacey Gilbert, portfolio manager for derivatives at Glenmede Investment Management.

Even so, with Election Day over, a massive risk event has been lifted from U.S. markets. Investors homed in on the presidential race as a volatility source nearly a year in advance. Cboe Global Markets listed October and November VIX futures earlier than usual so that investors could hedge for the event. VIX futures reflect volatility expectations for the 30 days following their expiration.

For much of the year - aside from the coronavirus-driven sell-off in U.S. stocks - October futures traded at a premium to other contracts as investors focused on the election as a major risk event. As worries grew over the possibility that a delayed or contested election result would prolong market volatility, November futures began trading at higher prices.

More recently, however, concerns about post-election market swings had begun to recede. In October, volume in VIX puts, used to position for a drop in volatility, surpassed volume in VIX calls, used as a hedge against a rise in volatility. That pattern continued in early afternoon trading on Wednesday.

The potential for extreme market gyrations is likely to diminish in the coming weeks, investors said.

“The big event is out of the bag,” said Michael Purves, chief executive of Tallbacken Capital Advisors. “Eventually things will become a little bit normalized.”

Reporting by April Joyner; Editing by Megan Davies, Aurora Ellis and Diane Craft