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uncertainty

Here’s How To Trade The Election

in Economy by

We’ve spilled quite a bit of digital ink explaining how the uncertainty surrounding the US election isn’t even close to priced in.

Have a look at the following chart from Goldman:

uncertainty

(Chart: Goldman)

And so, with the S&P at damn near 18X and bonds trading at historically stretched levels, here’s a rundown via Bloomberg on election risks and trades:

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TD (Priya Misra, Sept. 23 note)
Market is largely priced for a Clinton victory and continued gridlock in Congress, so if she wins the U.S. presidential election, might not mean much for markets
From a rates market perspective, Trump win should increase implied volatility due to heightened policy uncertainty
Election should be USD positive overall given prospect of fiscal stimulus, renewed weakness elsewhere and “intensification of geopolitics via a possible shift in NATO’s presence”

Schroders (Lisa Hornby, Sept. 20 interview)
U.S. election risk doesn’t seem to be priced into market; there’s “considerable amount of uncertainty under either scenario”
Strategy is reducing risk at the margins
Increase in fiscal spending would cause interest rates to rise, curve to steepen and would probably be inflationary in nature
Under Trump, fiscal deficit would likely rise; under Clinton, probably a bit less deficit spending but there’s a risk to what she could actually get done because Congress might be politically divided

Eaton Vance (Eric Stein, Sept. 20 interview)
If Trump were to win, could see more interest rate volatility and higher levels of inflation or expected inflation
Likes going long TIPs vs USTs
Clinton victory remains base case “but it’s certainly getting very, very close”

Vanguard (Gregory Davis, Sept. 22 interview)
In short term, uncertainty typically bad for markets when thinking of IG corporate spreads, stocks, high yields
Longer term, depends more on fundamental health of economy
Election could lead to increased volatility and some spread widening; longer term, not changing position based on election but making sure has ability to act when opportunities arise
Has been more conservative in investment grade space

Cumberland Advisors (David Kotok, Sept. 22 interview)
Going short duration in IG bonds and taking more defensive structures amid U.S. election risk; increasing cash reserves and overweight on energy equities such as oil, biased to U.S. natural gas
Unclear how much markets are pricing in political risk; both candidates and their parties are attempting to capitalize on fear
Each candidate poses “very large” market risks; Trump is an unknown and vague, while Clinton is likely to be closer to the continuation of an Obama-ese tax and economic policy “but beyond that I don’t think we know”
Likely to see a continuation of divided government, with intense and negative debate, with either candidate

Deutsche Bank (Joseph LaVorgna, Sept. 22 note)
“It’s hard to prove, but it feels as though the corporate sector has not been spending very much on investment,” reflecting uncertainty regarding the election outcome
Businesses will be most concerned with possibility of corporate tax reform and any fiscal stimulus policies
Make-up of Congress will also be important; worst outcome would be to have a divided government “and a feeling that we’re going to have four more years of gridlock”
“Any sense that the minority party is obstructionist would be bad for the economic outlook, because it would simply reinforce the trends that have been in place”

Credit Suisse (Praveen Korapaty, William Marshall, Sept. 22 note)
Trump presidency likely to be accompanied by wider deficits and meaningful boost to net Treasury supply and additional monetary policy variability
Would likely drive a 35bp-40bp widening of 10Y term premia on anticipation of added UST supply, steepen 5s30s curve
Clinton victory would be “status quo outcome,” should have minimal impact on U.S. rates
Wait for more definitive sign that Trump has passed “plausibility” threshold before taking positions to reflect “Trump risk”

Deutsche Asset Management (Stefan Kreuzkamp, Sept. 21 note)
“Too early to tell” what might happen in markets before Election Day; could be two scenarios:
Clinton retains lead in polls after debates, after which markets might treat the rest of the campaign as non-event; equity market might be more influence by global events and Fed speculation
Polls continue to tighten with occasional swings either way, though it’s unclear a close race would weigh permanently on market sentiment; if Trump feels he’s winning, he could be less erratic and more inclined to moderate his positions and investors might start to anticipate positives such as fiscal stimulus or infrastructure spending under a Trump presidency

Roubini Global Economics (Kevin Harris, Sept. 22 note)
Most likely election outcome is that government remains divided; even if Clinton wins, House of Representatives will probably retain a Republican majority
Senate could go either way, currently seems likely to swing to Democratic control
“A divided government would mean continued difficulty in passing government budgets, with attendant threats of government shutdown and debt default”
If Trump wins presidency, Republicans would likely retain control of Congress

BofA (Claudio Irigoyen, Ezequiel Aguirre, Sept. 22 note)
Stay neutral on MXN as U.S. election risks to remain high
Modeling that takes into account fundamentals but not Trump’s RealClearPolitics polling average shows MXN should be trading around 16.50/USD
MXN would likely “strengthen significantly” if Clinton were to win election

BofA (Michael Hartnett, Sept. 23 note)
Go long VIX futures, AUD/USD volatility among top U.S. election trades
AUD/USD volatility would benefit in a risk-off scenario in the event of Trump victory
Both candidates have policies targeted at raising wages and reducing inequality, which could lead to higher inflation or stagflation; will likely be positive for TIPS
Recommend selling USD vs MXN on a Clinton victory as MXN appears 15% undervalued after polls showing gains by Trump

Oxford Economics (Gregory Daco)
Effect of Trump policy proposals would range from modest slowdown in economic activity to a recession within first 18 months, “significantly weaker” than Trump’s projection of 3.5% growth over next decade
Clinton’s economic impact would range from neutral to modest positive boost

3 Comments

  1. I see the big picture being much different than current media election poles regarding a “close race.” Here are my assumptions:

    1. Voters are generally divided as 45% D, 45% R and 10% undecided/other;
    2. The R party is fractured today. Each fraction has highly divided and different agendas – divided unequally between the larger voting component of fiscal conservatives (financial industry and business interests) and the smaller voting component of social conservatives (tea party and other preservationist and or “regressionists” social conservatives);
    3. The D party agenda is essentially undivided between liberal socialist leaners and liberal “progressives.”

    Essentially, the D fractions are aligned, but the R fractions are highly divergent. In fact the Rs are more divergent this election than any in recent history. High profile and rank and file R fiscal conservatives are changing party affiliation and have been flocking to support the Clinton campaign in droves.

    Additionally and most significantly, while there has been a loud vehement negative response from social conservatives to the Clinton campaign, the overlap that exists between a significant number of R fiscal and R social conservatives (those voters that are actually both) means a significant loss of social conservative voters (not like the 2007 McCain/Palin R demographics) and support for Trump. Consequently, I think Trump will have much more dramatic loss in Nov. than the media currently tries to imply.

    Why? The media surveys don’t reflect the above logic because their agenda requires the polarization of all fractions – at least any that produce significant benefits to the media/advertising industry. Consequently, all media slants will be toward a “close race”, where “uncertainty stimulates media consumers and when in reality – there is no logic, or voter demographic quantification that supports the possibility of a close race based on a fractured R voter population – with fiscal conservatives voting D this time around.

    Here’s why: The media has become an expert in ‘selective polling’ to produce the necessary polarization in media consumers to insure that the public will consume more media/advertising on the subject. This polarization marketing effect is observable not only in politics, but in other similar polarized subjects such as anthropogenic climate change.

    All that said, polarized sentiments also drive markets and opportunities for trading – at least if you are aware.

  2. One more observation. I compared your GS Equity market uncertainty chart – to the price of gold futures (GCZ6) and to the gold miners (3x ETF NUGT) both of which are supposedly market sentiment/uncertainty driven. While NUGT amplifies and tracks gold futures quite well this year to date – I see no relationship at all with the GS Equity market uncertainty chart to gold market movements to date.

    I have no idea what GS bases their election uncertainty plotting on – I’m guessing investor “surveys.” However, I would take gold market movement as a much better indicator of “uncertainty” – election and otherwise ambient uncertainties – over GS investor surveys any day. All of which makes me more confident in my above opinion regarding the absence in reality of a “close race.”

  3. With bias/assumptions like those mentioned above combined with sources apparently well read in terms of reading each other I would totally agree: “the uncertainty surrounding the US election isn’t even close to priced in.”

    The reassuring aspect of the above views is, to paraphrase an old adage, ‘just because you are good at one thing does not translate into expertise in another.’

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