Market participants’ concerns about the prospect of a contested US election are becoming more acute by the day.
Although Republican lawmakers went out of their way Thursday to emphasize that the country’s system of governance is not at risk of being usurped, those assurances fell flat in the face of increasingly abrasive rhetoric from the man some call a would-be usurper.
US equities were headed for their fourth consecutive weekly decline Friday, and while losses earlier in September could be plausibly attributed to “de-frothing” in mega-cap tech following an options-fueled mania, it seems clear that election jitters and generalized concerns about D.C. gridlock are weighing on sentiment as the month draws to a close.
For their part, Goldman thinks concerns about a protracted period of uncertainty during which the outcome of the vote is unclear may be overblown or, if that’s too strong, suffice to say the bank’s Michael Cahill and Alec Phillips suggest markets are “pricing too high of a probability that it will take a long time to sort out the winner”.
In a note dated Thursday, they write that implieds are elevated “across a wide range of currencies, but especially in crosses where executive policy actions have had a substantial impact during the Trump Administration, and traditional safe-haven crosses”.
Some of this is down to what Cahill and Phillips call “muscle memory” from 2016. Obviously, some assets experienced outsized moves following Trump’s surprise win four years ago, as markets were suddenly forced to ponder a new macro environment defined in part by a rethink of globalization and a different approach to US fiscal policy.
Beyond that, though, Goldman writes that expected changes to voting behavior due to the pandemic have “raised the significant probability that the race could potentially take much longer to be called”.
The bank doesn’t deny that things are highly uncertain. But Cahill and Phillips write that while they “recognize the tail risk possibilities, we think market participants appear to be somewhat overestimating the probability that a delayed result prevents financial markets from reflecting the election outcome on election night or early the next morning”.
Specifically, they write that,
Rules for counting early in-person and mail-in ballots vary significantly state-by-state, with some allowing votes to be counted long before Election Day. Taken together with the fact that voter turnout and other sources of polling errors tend to be correlated across states, it seems fairly likely that there should be enough information on Election Night from states that will report results quickly for the market to be able to gauge the likely winner of the presidential race even if it is not officially called.
In the visual, the blue highlights indicate procedures conducive to earlier results. The critical point, Goldman says, is that “Battleground States allow for ballots to be processed and counted well before Election Day”.
This comes with all manner of caveats, and the bank acknowledges as much. For example, Cahill and Phillips write that while they “believe logistical challenges to reporting the results might be overstated, the possibility of a close election combined with legal challenges to results in various states could lead to substantial uncertainty”. They call that “a fairly small tail risk”.
Summing it up, Goldman says it’s likely that “the S&P can trade the outcome, even if the AP does not call the race”.
Of course, they don’t mention the real tail risk — namely, the outside chance that Trump, upon losing, simply refuses to hand the keys back or, say, declares martial law.
One can’t really blame analysts for not discussing such a scenario out loud. As noted in “Paper Tigers“, there’s no way to hedge that risk. So, for a strategist, it’s arguably irrelevant.
“Of course, they don’t mention the real tail risk – namely, the outside chance that Trump, upon losing, simply refuses to hand the keys back or, say, declares martial law.”
Or that heavily armed Trump supporters take to the streets or trucks to vent their fury at the “obviously fraudulent” outcome. Investment managers and analysts would be wise to go attend a few Trump campaign events in rural America before simply dismissing this as being a minimal tail risk.
But you can’t hedge that.
VIX?
Maybe some brave or foolhardy dealer or hedge fund would sell you some way out of the money USD puts. Lottery Tickets which would probably plunge in value if the transfer goes smoothly.
To the original question: What good is buying US equity vol going to do you if the country descends into anarchy? Nobody is going to care about the VIX if, to quote my long-time reader friend (above) “heavily armed Trump supporters take to the streets… to vent their fury”.
The point is, every derivatives strategist on planet Earth has done their absolute best to analyze this from all angles and determine whether or not options are pricing in too much, too little or just enough event risk across assets. But you can’t hedge an all-out civil war. That’s like asking a Seoul resident how they’re “hedging” a nuclear attack from Pyongyang. It’s like: “Well, I’ve got a basement. Does that count?”
Right you are, sir.
That “basement” statement got a laugh. You’re absolutely right, as usual. Moving to Iceland (or pick an island nation) is not a hedge.
I suggest taking a closer look at the Spanish Civil war and Madrid’s stock markets. They were closed between 1936 and 1940. It’s indeed a bad prospect if the US descends into armed conflict.
The longest-dated options on the SPY are for Jan20’23.
I sailed into a Trump boat parade, riotous. Tack and go the other way. Riots are riots and hopefully law enforcement can handle it. Guns will go off but hopefully into the air. Amazing how unhappy love makes people.
The country is in a flux. But if my guess is correct, we should have closure November 4, 2020. While there are a number of tail risks, the one nobody wants to really discuss is what happens if Trump gets blown out and the GOP is in shambles (in fact this may not be a tail- 30% chance right now is my estimate)? This election appears to rhyme with 1932 historically.
Again, Ria, I think you’re right. Despite Trump and his enablers’ (looking at you Barr and Meadows) best efforts, the outcome will be clear before the East Coast goes to bed on the evening of the 3rd. I don’t think Trump has expanded his support beyond his 43 percent MAGA base, and Biden is not making the mistake that HRC made (ignoring the Rust Belt). This will be a decisive win for Biden, and no amount of BS from Trump or Barr will change the facts on the ground.
Please correct me if I’m wrong, but if Trump challenges the validity of the mail in ballot papers, then it will also affect the House and Senate votes.
Well no, you can’t “hedge” anarchy – unless you’re talking about “investing” in canned food, toilet paper and ammo. Or perhaps purchasing a Santa Lucia passport ($100k for the whole family!) and some plane tickets. But Trump is already telling us what he’s going to do – contest the election and take it to the courts. I believe he’ll do that even if, as seems entirely possible, there’s a blowout win for Biden and the Dems on election night. But there’s a pretty big spectrum between that and anarchy. So – how about SPY puts, TLT, gold and cash? And be ready to cash those in around Xmas time, when things will (probably) have settled down? Because I believe that if it comes down to it, if the results are obvious and Trump is just fighting because that’s how he does, and he’s afraid of going to jail, then Roberts will vote his conscience and bring Gorsuch along with him. But who knows? What a time to be alive!
Unless I’m wrong…If the Senate counts the states electors decided by the voting and it turns out that Biden is the winner (and not close) then from that moment on the Secret Service has a new President to take care of and that means moving the usurper out of the White House and the new President in. And the secret Service does not move against itself. Trump will not have a choice.
Just two thoughts: 1) Nate Silver (very good pollster) has worked out the odds, and 4-5% loss in the popular vote still gives Trump a 1:10 chance of winning the Electoral College. I think break even odds at around a 2-3% loss. 2) speaking of the electoral college, it is a long and complicated process to go from the voting booth to the Presidency, involving certification of the slate of electors by a governor, to announcement of the slate of electors by the VP, to certification by the congress. So, as an example, if he is so inclined, Pence could insist on refusing to announce certain slates from states where he suspected vote counting problems, perhaps throwing things to the Supreme Court. Turns out, there are many potential power grab scenarios that could stem from what is usually a rubber stamp process.
Just to add…today I read an article by Jeffrey Toobin in the New Yorker which spells all of this out very well. Turns out, this is not just a vague, unlikely, fight over the elecotoral college slate. There is already an immense amount of litigation in half the states over voting rules which are laying the groundwork for contesting the balloting. It seems very clear from Trump’s statements that he intends to aggressively pursue such a strategy should he be “losing” on the face of things. Much more serious than I imagined, this is not just waiting a few days for the final vote tally, or Trump saying I actually won even though the rigged election said I didn’t. This is an already organized and mapped out legal strategy, and could easily be effective even if Biden has a “landslide” popular vote margin of 7%.
All that effort to contest a free and fair election, it’s too bad they didn’t spend half that on Covid. It couldn’t be plainer how bad this administration is.
I rate the odds of a Trump victory at more than 50% and rising. The real concern is what would happen after inauguration day. End SS and Medicare. Declares democrat congress members security risks and strips them of their seats. Starts repudiating USTs held my our “enemies.” Stations a huge carrier group in a blockade around Taiwan. Let your mind flow free. Who will stop him? Not the GOP. By the end of the war not even Hitler’s generals could tell him anything. Look at the big guys in Trump’s entourage, Pompeo Mitch and Hawley. Then, we get Tucker Carlson and Hannity coming soon to a cabinet near you.
Happy your odds seem misplaced.
I’m happy that at least one commenter has floated the idea of a victory for President Trump. Remember 8 years ago when the loser didn’t even have a concession speech prepared because it seemed so unlikely Senator Romney would lose; and 4 years ago when the polls already knew Secretary Clinton must win, only to demonstrate that polls are imperfect samplings.