Volatile swings in oil prices, driven by stalled diplomatic talks between Washington and Tehran, along with continued uncertainty surrounding the U.S. naval blockade and the reopening of the Strait of Hormuz, suggest that market volatility is far from over.
While markets have recently rebounded, recouping losses from the early phase of the conflict on the back of strong corporate earnings and a tech-led rally, the recovery may be masking unresolved geopolitical risks, possibly suggesting that investors could be underpricing underlying vulnerabilities and the potential for future disruptions.
The CBOE Volatility Index, which fell 9.48% over the past five days and 29.63% over the past month, gained about 1.24% in a single session, suggesting that volatility may not have fully subsided. Increasing exposure to volatility-focused funds can serve as an effective hedge against prevailing uncertainty, helping position portfolios for potential short-term downside.
Given the headline-driven nature of current markets, any unfavorable developments that are not yet priced in could trigger a sharp sell-off, reinforcing the case for maintaining tactical exposure to volatility strategies.
Extended Conflict Keeps Inflation Pressures Alive
The Middle East conflict has not only intensified geopolitical complexity in the region but also introduced broader macro headwinds, including rising inflation risks, slower economic growth and heightened global energy security concerns. Brent crude prices briefly surged to the $120-per-barrel mark this week before easing back to around $111, underscoring the sharp volatility and persistent uncertainty in energy markets.
Oil prices, which remain elevated above pre-conflict levels, have heightened investor anxiety around oil-driven inflation and continue to weigh on overall sentiment. Concerns about rising prices are becoming more persistent, as both inflation expectations and realized inflation have moved higher, with price levels increasing in March.
According to the Commerce Department, as quoted on CNBC, the core personal consumption expenditures (PCE) price index, excluding food and energy, rose 0.3% in March, lifting the annual rate to 3.2%, the highest since November 2023. Including the more volatile food and energy components, inflation readings were firmer, with prices rising 0.7% for the month and the annual rate reaching 3.5%, broadly in line with expectations.
However, Jamie Dimon, CEO of JPMorgan Chase, cautioned that stagflation ranks among the worst-case economic outcomes, although he remains relatively unconcerned about near-term inflation, as quoted on a Reuters article.
Volatility Extends Beyond Oil Prices and Inflation
According to the University of Michigan's Surveys of Consumers, in April, the Index of Consumer Sentiment and the Current Economic Conditions declined around 6.6% and 5.9% month over month and fell 4.6% and 12.2% year over year, respectively.
Additionally, while Dimon expressed confidence in the resilience of the U.S. economy, he highlighted cyberattacks and geopolitical tensions, including conflicts involving Iran and Ukraine, as among the most significant risks, as quoted on the abovementioned Reuters article.
At the same time, Dimon warned that any downturn in credit markets could be more severe than anticipated. Private credit has also emerged as a key concern for the banking sector, with investors assessing whether stress in the multi-trillion-dollar space could spill over into the broader financial system.
Why Volatility ETFs?
This environment underscores the need for a more tactical approach to short-term portfolio positioning, with increased exposure to volatility ETFs emerging as a compelling strategy, both as a hedge and as a way to capitalize on lingering market uncertainties.
Staying ahead of uncertainty is more effective than reacting to losses after they materialize. Positioning ahead of uncertainty allows investors to manage downside risks better instead of playing catch-up in volatile markets. Volatility ETFs, in particular, have historically performed well during periods of market stress and can continue to serve as effective hedging tools as uncertainty and downside risks persist.
While long-term investors may choose to look through near-term volatility, the current macro backdrop favors volatility-focused funds and strategies for those with a shorter investment horizon.
With the potential for increased volatility, adding these ETFs may be a smart strategic move (See: all Volatility ETFs here).
Volatility ETFs to Consider
Below, we have highlighted a few funds that investors can consider to gain increased exposure to volatility ETFs.
These are iPath Series B S&P 500 VIX Short-Term Futures ETN VXX, ProShares VIX Short-Term Futures ETF VIXY and ProShares VIX Mid-Term Futures ETF VIXM.
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iPath Series B S&P 500 VIX Short-Term Futures ETN (VXX): ETF Research Reports
ProShares VIX Short-Term Futures ETF (VIXY): ETF Research Reports
ProShares VIX Mid-Term Futures ETF (VIXM): ETF Research Reports
This article originally published on Zacks Investment Research (zacks.com).