After initially reacting positively to Trump’s election, the US equity market began to shift dramatically in the first quarter of 2025. On April 2nd, Trump announced a series of tariffs that vividly brought to life the narratives he had championed during his campaign and early time in office. The US Economic Policy Uncertainty Index has soared to levels only previously seen during the COVID-19 outbreak in 2020, leaving investors, policymakers, and market leaders alike wondering what’s next? The negative market reactions to these tariffs, coupled with growing concerns over potential withdrawals of economic support, have significantly amplified the uncertainty. As of April, the S&P 500 index has fallen 13.9% year-to-date.
The Impact of Policy Uncertainty on Market Volatility
The natural question to ask is just how much has the economic policy uncertainty translated into equity market volatility and how do investors perceive this risk going forward?
In the past we can see a clear relationship between spikes in economic policy uncertainty and spikes in market volatility. For example, if you look at the spikes caused by the dot-com bubble, the global financial crisis and the COVID-19 outbreak.
During 2024, both historical and forward-looking volatility measures hit record lows. This reflected a period of stellar US equity market performance compared to global counterparts, with an overall environment characterised by low volatility. Despite the spike in economic policy uncertainty, these levels were slow to react to the narratives posed by trump. However, in the first quarter of 2025 we have seen an uptick in realised volatility of the US equity market, showing that the heightened uncertainty has indeed manifested in the day-to-day fluctuations of market prices. Notably, after Trump’s announcement, the S&P 500 experienced its fifth worst two-day return in its history.
The case is similar for the market’s forward expectation of risk. For this we use the 3-month implied volatility. Where a large increase is also evident. This is a signal that investors believe the future volatility of the market is on the up and as a result investors may be more willing to pay for downside protection through hedging strategies.
While these volatility levels remain lower than those witnessed during the COVID-19 crisis, the key takeaway is that the market volatility has shifted well above its long-term average.
How does volatility translate to equity performance
At Prescient Investment Management, we use the market’s forward-looking volatility as a gauge of investor sentiment. The higher the implied volatility, the greater the perceived risk—and the more investors are willing to pay for downside protection. When volatility reaches sufficiently high levels, we interpret it as an indication that the market is overly pessimistic, which we then view as a bullish signal. Our quantitative models have shown that this signal can predict equity market performance, so we incorporate it into our US equity views.
As of April, the volatility indicator is around its long-term average, which would suggest a positive stance if considered in isolation. However, when forming an overall view on an asset class, we evaluate multiple indicators and their interactions. While the volatility metric alone points to neutrality, our broader analysis – taking into account factors from valuations, economics, financial conditions, and sentiment—leads us to maintain a moderately negative outlook on US equities.
By: Nicholas de Clercq, Quantitative Analyst at Prescient Investment Management