Schwab's Randy Frederick on his outlook for the market as the election approaches

Randy Frederick, VP of Trading and Derivatives at Schwab's Center for Financial Research, joined The Final Round to recap today's market action and his outlook for the market as we approach the election.

Video Transcript

SEANA SMITH: Let's get more on today's market action with the NASDAQ reporting its worst week since March, that's nearly six months, Dow and S&P, their worst weeks in 11 weeks. So for more on today's sell-off, we have Randy Frederick. He's VP of Trading and Derivatives at Schwab's Center for Financial Research.

And Randy, let's talk about today's jobs report, the sell-off that we've seen, really yesterday's sell-off, and then today's declines with the Dow, S&P, and NASDAQ all closing in the red. What's your reading on this decline that we've seen? And what do you think's triggered it? I guess, what do you think of Myles-- what Myles brought up, the fact that maybe SoftBank had played a big role in this?

RANDY FREDERICK: Well, I think that's definitely part of it. The jobs report was pretty good. In fact, futures were pointing to a lower open. And then when the jobs report came out, virtually every component of it except one, and it just barely missed, was better than expectations.

As a result, we got a little bit of a bump at the open. But then the sellers stepped in, just a continuation of what we saw yesterday. I do think the options market is a big piece of that. That's obviously a big part of the work that I do.

One thing that I've-- or a number of things I've pointed out over-- over the last few weeks is that equity option volume has been huge. The ratio of call options to put options has been about, let's see, about four puts for every 10 calls, so that's not very-- that's about as low as you can get in equities. And the equity options tend to be-- have a very large retail component to them.

The other thing is if you look at total outstanding contracts, so open interest numbers, on a year-over-year basis, equity options outstanding is 30% higher than where it was a year ago. And in fact, if you look at the industry as a whole, volumes this year are on pace to be not only the largest year in history, but a 25% increase overall versus calendar year last year. So there has been a lot of activity going on in the options markets. That has had a huge part of it, and it's not just-- and it's not well-balanced. It's-- it's big volume, and it's big volume on the call sides, which does create the kind of situations that you're talking about.

Another component to that, of course, is also the futures market. So people pay a lot of attention to the VIX Index. The VIX Index is actually not an instantaneous look at volatility like many people think it is. It's actually looking out 30 days into the future.

Now that we're only 60 days away from the election, the VIX Index itself is being heavily influenced by the VIX futures markets. There's a pretty big spike in volatility in the September contract and a huge spike in the October contract, which expires about two weeks before the election. That spike has been present since all the way back in January when that contract first became available.

Now, the whole curve has shifted up down a little bit based on things that have happened here recently, but that spike is still noticeably there. So as we approach the-- the election, the two contracts have to converge at expiration. This big spike we got in the VIX Index this week has now made it right at the same level as the September contract, but we still got a ways to go to get to the October one, which means even if things calm down, it's likely that volatility or-- in terms of the VIX are going to continue to trend higher as we approach the election, because there's just huge amounts of uncertainty about what might happen.

SEANA SMITH: So Randy, does that mean that we could see more days like we did yesterday, I mean, nearly 1,000-point drop in the Dow? I mean, when you take a look at the low of the Dow today, we are off almost 600 points. So those types of drastic moves, is that what we could expect here over the next two months?

RANDY FREDERICK: Not necessarily. So in an environment without outside influences, you oftentimes will see the market and the VIX move in opposite directions. But we're being-- there's a significant outside influence there. There's this level of uncertainty that's been there for a very long time about what might happen in the election.

Now, what makes that tricky is it's not just the presidential election, it's also the Senate, and the House, and the makeup of the three. And then there's the element of, well, even if we knew what the outcome of the election was going to be, would we know how the market was going to react to it? Conventional wisdom is often wrong on this.

And I just go back to 2016. Most people would have told you prior to that election not only was President Trump not going to win the election, but that if he did the markets would go down sharply. Well, if you were awake in the middle of the night, you know that they did, but it only lasted for a few hours, and they've been going up ever since.

So even if we knew, it's not the fact that we know the market's going to go down. It's that what the VIX really tells us is-- is not that it's going down, but that we don't know which way it's going to go. And that's really what the gauge is.

It's gauging the uncertainty, how confident are we in our ability to forecast at that point. That is going to have an influence on the VIX Index. That doesn't mean the market's going to necessarily go down, but it does mean we may have more up and down days, because volatility means both direction will move.

SEANA SMITH: Well, Randy, taking a step back, then, since there's so much uncertainty out there, obviously a lot of these big tech names have been attracting most of the money here, most of the investors' attention, where are you seeing opportunity at this? But we've seen a bit of a rotation into some of these cyclical sectors over the last day or two. I guess you have-- we've seen it here and there, but it hasn't really stopped. What do we need to see in order that to stick? And where are you finding opportunity?

RANDY FREDERICK: Right. So there's two key components to that. One is the longer-term trend. With the exception of the very, very short bear market that we had between 02/19 and 03/23, the longer-term trend continues to be higher. And as long as that's the case, the-- the leaders that have been the leaders for the last 11 or 12 years, technology and consumer discretionary, are likely to continue to be the leaders.

When you have these counter-cyclical trends like we had in the last two days, like we had-- and if you pay attention to what happened the last two days, it looks very similar to what happened back on June the 11th and those three-day period. When you have those types of moves that-- that pull things back and get things realigned, you know, corrections as-- or just pullbacks, then you will typically see a rotation out of those sectors where they're highly priced, people take some profits off the table, and they'll tend to jump into areas that are a little bit more affordable.

The one area of the market that we've had an outperform rating on at Schwab, for a good reason, is the financial sector. Now, you might think, well, that doesn't make a lot of sense with low interest rates, but it's one of the few sectors that has been an underperformer this year. It doesn't have the kind of structural issues that the energy sector has.

And assets in that area are a little bit more affordable than some of the others. So when you see people take money off the table in high-performing sectors like consumer discretionary or technology, they'll tend to look for bargains there. And if the bull market continues and it broadens out, which is a good thing, you will typically find people doing bargain hunting in areas like that.

SEANA SMITH: Well, financial certainly a winner in today's market. Randy Frederick, VP of Trading and Derivatives at Schwab's Center for Financial Research, always great to have you on the program. We'll see you soon.

RANDY FREDERICK: My pleasure.