Hello readers of NishaTrades: welcome back! I hope that you all have been keeping safe and healthy these past few months. Quarantine has wrought an unprecedented cloud of uncertainty over all of our lives, in both the personal and political scope, and in today’s post I wanted to share a couple ~trading~ takes with regards to the upcoming presidential election this Tuesday. Over the course of the past seven months, we’ve seen a wide range of unprecedented measures in response to the pandemic. From lockdown and the liquidity crisis to reopening and seemingly restored markets, this time period has certainly been pivotal. And now, we have a critical election ahead of us. The results will undoubtedly have important implications on the social, economic, and political direction of the US. It additionally portends a lot for financial markets! These are a couple learnings/thoughts of mine surrounding the next few weeks ahead:
The onset of the pandemic put a grinding halt to an otherwise consistently bullish stock market during Trump’s administration. This sentiment driven selloff was spurred in part by investor concern about companies’ ability to retain revenue and meet debt obligations amidst an entire reset of daily business operations. Into the summer however, we saw the market rebound and become further detached from the economic reality unfolding around us (though small caps traditionally remain more levered to the economy). Technology stocks buttressed the new summer daily highs, and further drove a wedge between value and growth opportunities.
Per Tastytrade research (linked below), stocks have historically rallied before the election, begun selling off during, and selling off even more post. Regardless of an incumbent win or not, we’ve additionally seen greater stock volatility around Democractic victories (~7.4% dips post-Democratic wins vs. 2.5% rises post-Republican wins). This makes intuitive sense as the stock market would favor a “pro-business” president; investor sentiment on company earning potential stands to weaken following a Democratic sweep, and the likely concomitant corporate taxation to follow.
From consistently buying safe assets like treasuries and agency MBS throughout the spring and summer, the Fed infused the credit markets with much needed funding. Ever since, much attention has not only been drawn towards tightening credit spreads, but also the improving fundamentals underlying investment grade credit opportunities. In response to attractive low rates amidst a relatively stable fixed income environment, companies alike have dedicated efforts towards deleveraging and cleaning up their balance sheets.
Additionally, all eyes have been on Jerome Powell and rates, however it’s worth also noting the impacts that differing legislative and public stimulus plans will have on credit markets. A disruptive Democratic sweep of the executive and legislative branches, could mean a reversion to higher corporate taxes. Higher corporate taxes makes tax shields from debt (the amount less that a corporation has to pay in taxes of their income) more attractive. As a result, we’ll likely see continued corporate debt issuance. With regards to public stimulus, a Democratic executive and legislative branch could potentially mean a more stifled stalemate on recovery plans, though it's challenging to project how this potential semblance of cooperation will translate to the economy, and by virtue, markets too.
In a side note about rates: Historically in elections, Fed changes to rates have appeared partisan; however, given prior guidance and the unique economic environment in which we’re operating, it’s unlikely that the Fed will deviate from anything other than its consistent zero-bound path. Per Tastytrade research, historically interest rates often fell before and rose after Democratic elections, and vice versa for Republican.
A common thread: the outcome is uncertain. And where there is uncertainty, there is also opportunity! Whether it be an equity market reaction or a credit selloff, regardless of asset class or fundamentals, we can expect and have already seen high volatility. Taking a quick glance at S&P 500 Futures, as expected, we can already see this! Futures expiring Monday 11/2 are trading at 44.82% (+ or - $44.8) volatility, while those expiring Wednesday 11/4 are at 59% (+ or - $117.40). The difference between the dollar standard deviations from Monday to Wednesday are indicative of the overwhelming uncertainty that the market already priced in. A Biden win offers up a lot of potential for option sellers around a greater and more elongated volatility squeeze. Risk-hedging and directionally-neutral trades to consider could perhaps be short iron condors or call spreads, with the potential to calendarize as volatility tapers into the following months!
Thanks for reading! This post drew inspiration moreso from my increasing interest around the connection between macro events and markets. If you’re similarly interested in exploring more, I particularly enjoyed + learned a lot from:
Ninteen year-old trader, future connoisseur of options.
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