Weekend Thoughts On The Election

On Friday, we brought you Goldman’s recommendations for how to trade the upcoming US presidential election.

In a nutshell, you want to be long stocks with a significant proportion of revenue derived domestically and you want to get long anything that benefits from fiscal spending. This is obviously a reflection of the expectation that both candidates have alluded (and in Trump’s case we use that term very loosely) to protectionist measures and fiscal expansion to bolster the still floundering economy.

The problem though, as we’ve outlined on too many occasions to count, is that the market just isn’t pricing in any risk. It’s as if this were a race between Joe Biden and Jeb Bush. There are very real questions on both sides of the ticket here and when it comes to uncertainty and vol, no one seems to be factoring that in.

That’s not to say everyone should suddenly sell everything (although at nearly 18X on the S&P and bonds stretched to the absolute breaking point there’s a case to be made there), it’s just that it’s a complete mystery as to how we could be sitting at a 12-handle VIX under the circumstances. Well, actually it’s not. It’s central banks and most especially the Fed who almost certainly will not chance a hike until after the election. But even there there’s uncertainty. Donald Trump has said Janet Yellen should be “ashamed of herself” which certainly seems to suggest that a Trump White House would think seriously about shaking up the Fed.

In any event, regular readers probably are aware that we’re fans of Deutsche Bank’s Aleksandar Kocic, who writes the derivatives section of the bank’s weekly US fixed income note. He’s a veritable genius and is out this week with some good commentary on the election and what it means for markets. Here are some excerpts:

“In the remainder of the year, the main source of volatility is the US presidential elections. When taken at face value (which most likely is a stretch), campaign rhetoric carries a promise of taking the markets in two completely different directions leading possibly to highly divergent economic paths. Irrespective of the actual delivery, such diversity of outcomes could be a source of considerable short term volatility and big swings in positioning depending on the polls. This anxiety is especially going to be pronounced after Brexit which has undermined the credibility of previous interpretive frameworks of poll results and political risk.”

“Without going into all permutations of possible outcomes in terms of president vs. congress vs. unified or split government, we distinguish between two cases, Clinton with divided government vs. Trump with republican sweep and unified government. They outline the two boundaries of possible market responses.”

“Election of Clinton (divided government) is most likely a status quo and ongoing financial repression with market reaction biased towards flatter curve and lower volatility. The environment would be mildly supportive for risk and possibly USD. This is the carry trade environment bearish for volatility. Given the current decline in gamma, pressure on vol would propagate across the term structure. We are sellers of intermediate straddles, buyers of 1X2 receiver spreads and sellers of payers in the belly.”

“Trump, with Republican sweep and unified government, when taken at face value, would be consistent with a protectionist economy, tariffs, economic rigidities, higher prices with higher inflation expectations, and lower growth. FX volatility would likely rise as well as yields and rates volatility. The market would price a stagflationary scenario as the first order reaction. This is bearish for risk, USD and possibly credit. Given its disruptive overtones it has a potential to trigger a risk off trade. Lower growth would mean Fed behind the curve and, therefore, bear steepeners. In the near term, we are buyers of curve steepeners and equity put spreads. As an alternative, we would sell rates vol with limited downside to finance call spreads on VIX.”

This is pretty much consistent with what we’ve been saying for quite sometime. Trump is a “black swan walking.” That’s not a political statement. It’s a market-based reality. Risk is not going to like it (short-term anyway) if Trump is elected in November.

And here’s the thing: the right-wing media has managed to drum up enough concerns about Hillary Clinton’s supposed health problems to create a self-fulfilling prophecy. That is, if the media tells you you need a Diazepam injector, you might just start to believe it - not because you have seizures, but because of the sheer pressure of running for President. The Secretary’s husband didn’t have this problem. He was unflappable. But Trump is on the verge of being just disruptive enough to win.

Buy your popcorn (and maybe your puts). The debate is next week.

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  • Mark

    September 24, 2016

    Popcorn is ready, this'll be like Ali- Frazier.

  • AA2

    September 25, 2016

    Market based reality and not political! That's rich. The current Alice in Wonderland markets are composed entirely of Black-Swans. How then does electing the status quo which has been instrumental in creating the current situation result in less risk? On the other hand I appreciate you taking the time to explaining how only one candidates failings are fabrications of the media. Especially when the media you refer to is the all powerful right-wing media. Ben Rhodes had a different take on media bias, but since you indicate your not political well that's different, never mind. Happy trading or astro-turfing.