Top Market Opportunity in 2026: A Rise in Volatility Across Markets

Talking Points:

• Risk appetite swelled and collapsed across the markets after the Liberation Day reciprocal tariffs were announced in April and reversed soon after
• What was initially an opportunistic bid on the dip after the tariff discount, turned into justification through AI and other themes that grew increasingly long-in-the-tooth
• Risk appetite can hold out if fundamental meet the lofty expectations, but expecting low volatility amid an ‘oblivious’ threat outlook well into 2026 seems highly improbable

Markets experienced a few jolts of volatility through the past year – April’s tariffs charge, October’s US government shutdown and November’s monetary policy perspective pivot – but those short-term charges consistently retreated from their extremes and back to the general underlying trend. While the brief bouts of fear provided significant market impact, the persistence of benchmarks for sentiment – like the S&P 500 or Dow Jones Industrial Average – moderated the ultimate impact that these readings would otherwise exert on broader conviction.

With US indices lingering near record highs and so many other sentiment measures similarly elevated historically, it is easy to fall into a belief that the quiet advance will automatically persist into the new year. This seems further supported by the moderating influence for many of the systemic fundamental themes from the past year: tariff-driven geopolitical risks and inflation expectations; transition of monetary policy trends; economic pacing threats and fiscal stability issues. That said, it is worth noting that the norm with which spikes in volatility reverted to was ultimately on a steady trend higher. For reference, the 13 and 26-week (quarter and half-year) averages of the VIX volatility index have risen substantially from the Summer 2024 lull. We can see similar measure through the medium-term’s 3-month VIX.  

Chart of VIX Volatility Index (Daily)

Source: TradingView, John Kicklighter

There is a ‘chicken and the egg’ debate over market volatility. Some believe that volatility will rise when market catalysts present greater uncertainty and thereby price volatility. I agree with that, particularly when it pertains to short-term swells in volatility readings. However, it is more frequently the case that market conditions establish the environment with which event risk draw experiences are greater or lesser market-moving capacity. With the trend in underlying implied volatility rising against the backdrop of record high markets (leading to a discordant risk profile and hedging costs), it seems more likely that the backdrop will establish an environment where updates will trigger bigger movements.

What’s more, this isn’t just a reflection of US markets – much less US equities as is reflected by the VIX – but has the potential for the financial markets at large. Trends higher in speculative assets like equities and Bitcoin as well as financial stability representatives like gold suggest a spillover of uncertainty can happen from core markets across the board. And, ultimately, the wider the reach of volatility, the more systemic and persistent it will be for the financial system. When the markets are ready, they will have their pick of traditional justifications to draw from.

Chart of VIX Volatility Index (Daily)

 

Source: TradingView, John Kicklighter

For taking advantage of volatility, there are a few approaches to take. Attempting to take a view through the derivatives based on measures like the VIX itself are not particularly appealing because of the time restrictions of the derivatives and inherent flaws for some of the more popular exposures (like the VXX iPath Short-Term VIX Futures ETN). Instead, I like to monitor the implied measures as a gauge to reflect a sustainable rebound in conditions. Then, it is finding those underlying markets with a strong correlation (inverted for many) to the VIX itself.

The S&P 500 has one of the most consistent negative correlations to the VIX (across durations) and that should make sense as it is derived from the indices’ derivative measures. That said, the speculative nature of the options pricing the VIX has seemed to override the hedging capacity of the products. That has moderated its signal power for implied (expected) volatility, but it also weakens its guidance capabilities for the S&P 500 itself when separating a quick pullback from a lasting trend.

Chart of S&P 500 and Inverted VIX 3-Month (Daily)

Source: TradingView, John Kicklighter

 

A little further afield than the direct VIX-S&P 500 relation, but adding in additional fundamental consideration, is the USDJPY. Historically, Yen crosses have played the role of carry trade with the Japanese currency providing the ‘funding’, or short side. That is owing to three decades of essentially zero interest rate which has pushed Japanese investors to send their capital abroad for meaningful return. However, the BOJ has been on a slow hiking regime this past year to slowly eat into the carry trade while major counterparts have experienced a dovish cycle from their own monetary policy groups. That has materially lowered the yield differentials for the likes of USDJPY and other crosses.

That said, there remains a hearty positive carry for pairs like USDJPY which can appeal in the environment where complacency keeps risk appetite bid. Alternatively, should fear start to break through the status quo and generate more significant market volatility and broader uncertainty along with it; this carry-price divergence is more likely to close. While the Yen is not necessarily a more appealing haven than the US dollar, the first consideration towards a sentiment shift is to unwind extended exposure (eg long carry) rather than seek out absolute risk-free haven (eg Treasuries priced in dollars). Add to this a pressure from Japanese authorities worried about the purchasing power of a weak Yen, ready to take advantage of market natural market swoons potentially through intervention; and this seems a pair to watch in the context of volatility trends.

Chart of USDJPY, US-Japan 2-Year Yield Differential, Inverted VIX 3-Month (Daily)

 

Source: TradingView, Standard & Poor’s, John Kicklighter

-- Written by John Kicklighter, Global Head of Content