VIX vapour rising: Election-related anxiety catches up with the markets

Volatility index shoots up days after a record low

The India Vix, or the volatility index, dived 20 per cent to close at an all-time low of 10.2 on April 22, just days after India's marathon seven-phased elections commenced.
 

This, experts thought, was unusual.
 

A measure of the market's expectation of volatility in the next 30 days, the Vix is also called the “fear gauge”. Lok Sabha elections are usually a period of volatility for the markets and anxiety for traders.
 

The Vix is computed on the basis of the NIFTY Index Option prices. The higher the reading, the higher is the expected volatility. A lower reading says option traders do not expect huge gyrations.
 

That all-time low now appears much further back in time than it actually is.
 

Between April 23 and May 9, the India Vix index rose for 11 straight sessions to 18.2, its highest close since October 17, 2022. The benchmark Nifty 50 index, too, has come down 3 per cent from its peak, while the Nifty Midcap 100 and the Nifty Smallcap 100 indices are down 4 per cent and 6 per cent, respectively, from their highs, registered on May 2.

 

A reading of less than 20 for the Vix is still considered benign, but the rise is being seen as a sign that complacency is giving way to some anxiety.
 

A harbinger
 

Market experts say traders are fretting over the voter turnout and have mixed feelings about an emphatic election result. The latest Vix reading is being seen as a harbin­g­er of continuing volatility in the run up to the election results on June 4.
 

“Elections are always difficult to predict and even exit poll experts can get them wrong. The market seems to be already assuming that the current government will be re-elected, so any change of government would be a negative surprise,” said Pratik Gupta, CEO & Co-Head, Kotak Institutional Equities.
 

Macro uncertainties are also seen to be stoking the volatility.
 

“The markets are likely to enter a phase of greater volatility on account of multiple events, such as the Lok Sabha elections, the monsoon, inflation, Central bank policies, and the US elections later this year. Some bit of correction is not ruled out. Also, the market could see some sector rotation with defensive stocks coming back in focus. However, so long as the visibility of a 15 per cent corporate earnings CAGR is not materially challenged due to these events, deep corrections in the market may be unlikely,” said Taher Badshah, Chief Investment Officer at Invesco Mutual Fund. CAGR is short for compound annual growth rate.
 

 Wild swings
 

The average swing – swing is the difference between a day’s high and low - seen in the benchmark Nifty50 index on the previous six election result days is a staggering 8 per cent — the highest being a near 20 per cent swing on May 16, 2009, following the victory of the Congress-led United Progressive Alliance. During the April-June period of the three previous election years, the India Vix averaged nearly 30.
 

In 2009, the benchmark Nifty moved in a 50 per cent range during these three months. The movement was relatively low, but still significant during 2014 (15 per cent) and 2019 (8 per cent).
 

Such wild swings during election time explain the elevated levels of India Vix.
 

So, what was behind the sharp drop in the Vix on April 22?
 

Some cite technical factors: The National Stock Exchange halved its derivatives contract sizes. The consensus view is that market participants were not losing sleep over the elections this time, with opinion polls indicating that the current regime would return with a comfortable margin.
 

On May 2, the benchmark Sensex and Nifty, as well as the broad-market mid- and small-cap indices, made fresh lifetime highs.

During the 2009 election cycle, the Vix averaged 45 during the April-June period. By comparison, it has averaged just 12.8 since the start of April this time around.
 

Storm after the calm
 

The recent surge in the Vix comes after a prolonged calm for India’s $4.8 trillion domestic equity markets. Since the start of 2023, the average reading for the India Vix has been 12.8.
 

While there have been murmurs about India’s expensive valuations, sustained flows from foreign portfolio investors, domestic mutual funds, and individual investors have kept the outlook largely positive, and Vix at benign levels.
 

The outlook remains largely positive, given the healthy growth outlook, but experts believe the markets are vulnerable to any bad news, as they are counting on certain outcomes.
 

The surge in the Vix signifies that traders want the markets to leave some room for error.

 

“The Vix gives a peak into whether there is nervousness among traders with regard to the market direction. Over the past 15 months, the index was relatively benign as stocks enjoyed a good run. Typically, during elections, the Vix tends to flare up given the magnitude of the event and given how markets have reacted in the past. Even in 2019, the index went up. This time around there was a lot of complacency before the big event. However, the voter turnout is making traders nervous and is spooking the markets,” said Sriram Velayudhan, Senior Vice President, Alternative Research, IIFL Securities.
 

Which way Vix?
 

Experts believe investors have to brace for more volatility. Looking at the Vix is just the starting point, and that traders should also look at other lead indicators.
 

“I would suggest that, along with the Vix, investors should refer to other indicators to get a better sense of market direction. Some of these are the advance-decline ratio, open interest, put-call ratio, stocks hitting 52-week high vs 52-week low, and percentage of stocks trading above their daily moving averages,” said Velayudhan.
 

“Higher volatility” is often accompanied by price corrections. To be sure, equities by nature tend to remain volatile as their returns are not linear in the manner of fixed income. However, wild swings in the market tend to deter investors from investing.

Experts say given the anticipated spike in volatility investors may need to realign their portfolios. They believe small caps and high-beta sectors, such as real estate, auto, and metals, could be the most vulnerable to wild swings. If someone has a large concentration of these stocks, the volatility in their portfolio will be higher. On the other hand, pharma and FMCG stocks could see relatively lesser swings.
 

Also, stocks linked to fortunes of political parties could see higher volatility.