Embrace volatility and find opportunities

AS A derivatives strategist by training, I have always followed the moves in Vix, the short-term S&P 500 volatility index. After a brief spike following US President Trump’s “Liberation Day” in April, when he announced stiff tariffs on US imports, the Vix index has pulled back sharply, and we have been experiencing a low-volatility environment in the last few months.

Macro data drives the narrative

However, Vix may soon see a short-term spike. Macroeconomic weaknesses are usually a key factor driving volatility higher. The last couple of US non-farm payroll numbers have been weak, and there have been negative revisions to prior months’ data.

If we regress the key equity market drivers – such as leading growth expectations, the stage of the business cycle, investor sentiment, risk and valuations – against the past performances of the S&P 500 index, we can see that the probability of a 10-20 per cent drawdown over a three to 12-month horizon is around 25-30 per cent. That is not high, but certainly not trivial either.

We have since seen rising volatility. Currently, the Vix – which measures the short-term implied volatility of the S&P 500 index – is expensive versus the realised or actual volatility of the S&P 500 index. There has been a sharp surge in trading volume on Vix-linked exchange-traded products over the last few months.

Micro factors support low-volatility environment

Looking at micro factors, such as corporate earnings trends, there has been very little growth outside the top 10 US stocks in terms of forward net income over the last three years. The mega-cap technology sector’s stocks are still driving the S&P 500 index’s record-breaking performance.

Is this good or bad news? Well, if the prospects for these mega-cap stocks deteriorate, then this over-concentration can hurt. However, the earnings of the mega-cap companies have been strong, and forward guidance remains exciting.

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In the most recent Q2 2025 earnings season, the magnitude of upside moves following positive earnings versus negative moves was the largest in the past two years. This should limit the magnitude of any sell-off in equities.

The secular artificial intelligence trend, as well as deregulation in US banks, should drive technology and financial sector equities higher. Interestingly, despite the intense spotlight on these two sectors, their year-to-date outperformance versus S&P 500 is just around the average of the last 10 years.

Hence, there is a reasonable chance that the two sectors can sustain, or even accelerate, their outperformance in the coming months, leading to more dispersion or differentiation in performances across S&P 500 sectors. The outperformance of these sectors can cancel out underperformance of other sectors on an index level, leading to lower index volatility in general.

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Volatility creates opportunities

The US Federal Reserve continues to strike a fine balance between supporting growth (which argues for more aggressive rate cuts) and avoiding a jump in inflation expectations (which argues for a much more cautious approach to easing policy). Federal Reserve chair Jerome Powell sought to strike this balance by calling this month’s rate cut a “risk management” cut. But we believe there is room for more rate cuts in the coming months to support growth. Easier monetary policy should provide added support to equities.

Some indicators of equity market positioning show pockets of exuberance in global equities in general, and several US and China equity sectors in particular. However, this remains a weak signal as only some, and not all, positioning indicators are stretched. This suggests positioning could normalise amid an extended period of equity market consolidation or with a shallow pullback.

In conclusion, our long-term quantitative models are still giving positive signals for equities; Fed rate cuts still support our soft-landing view for the US economy; and recently strong upward revision in earnings expectations mean we would view any such shallow pullback or sideways consolidation as an opportunity to add to equities, with a preference for Asia ex-Japan markets, and preferred equity sectors in the US, such as technology.

The writer is head of equity strategy at Standard Chartered Bank’s wealth solutions chief investment office