Analysis-Fearless US stock market vulnerable to shocks as midterms loom

NEW YORK, Sept 9 (Reuters) - With two months until the U.S. midterm elections, the options market is showing a potentially toxic mix of fragility and fearlessness, with some analysts worried markets are ill-prepared to absorb any shock.

Despite recent bond market volatility, stocks remain near record highs, volatility ‌measures are near 2026 lows, and equity market correlations are flirting with record lows, meaning stocks are moving more independently than usual.

While analysts do not expect the ‌elections themselves to prompt a big market reaction, the run-up to the November 3 vote could be volatile.

As the elections approach, investor focus could turn to the uncertainty over control of Congress and its policy implications — along ​with the risk of a divided or fragile government — which could stir volatility, analysts said.

Historically, the September-October lead-up to the midterms has been a volatile period for equities as markets exit the typically quiet summer months and investors zero in on political risk.

The S&P 500 has dropped 5% or more during the September to October period in 15 of the 24 midterm years since 1930, according to a Cantor Fitzgerald analysis.

But you wouldn't know that from looking at volatility futures.

The options-based investor anxiety gauge, the Cboe Volatility Index, recently touched a new low for the ‌year. At around 15, it is below its long-term median ⁠of 17.6. VIX futures also look calm, as investors remain confident strong corporate earnings will continue to support markets.

"The VIX curve is not expressing any premium for midterm elections," said Michael Purves, CEO of Tallbacken Capital Advisors.

A plethora of potential catalysts — including data on inflation and jobs, a ⁠Federal Reserve meeting, and a late-September U.S. visit by Chinese President Xi Jinping — fill the calendar over the next two months, culminating in the midterms.

The elections themselves have market implications, some analysts said. The Democratic Party has gained a significant edge over Republicans in voter perceptions of which party has a better approach to the cost of living, a troubling sign for President Donald Trump's party, a ​Reuters/Ipsos ​poll found.

Should Democrats wrest control of the House of Representatives, the shift from one-party control of the ​White House and both chambers of Congress could add uncertainty to ‌markets, Julian Emanuel, lead equity and quantitative strategist at Evercore ISI, said in a note.

"A Senate flip would magnify the dynamic," Emanuel said.