The Best-Laid Plans Of Traders And Pollsters

Escalating rhetoric from Donald Trump and lingering suspicions that, after 2016, the polls can’t be trusted, are keeping market participants on edge.

Although the president’s chances of reelection are now low enough that even Lindsey Graham is telling Fox News he might lose (and that’s to say nothing of Graham’s own trials and tribulations) it’s difficult to escape the feeling that various polling and betting odds don’t tell the whole story.

Importantly, don’t forget that when it comes to near-term, tactical considerations for market participants, the margin matters perhaps more than the outcome. Obviously, the vast majority of humanity has a strong opinion on who they’d like to see prevail next month, but a hypothetical, emotionless trader (e.g., a robot) will care more about the margin of victory/defeat when assessing how to maneuver around the event.

The figure (above) is from the latest edition of BofA’s Global Fund Manager survey and the message is crystal clear. When it comes to outcomes with the potential to inspire volatility, a contested result is seen as particularly dangerous.

While there’s some risk of Biden contesting the results in the event Trump manages to pull off a come-from-behind, narrow victory, the real risk is a close vote that results in a Trump loss. That would open all manner of doors, none of which lead to happy places.

But increasingly, fears of the worst-case outcome (defined in general terms as a prolonged period of uncertainty that drags into December) are seen as overblown, while worries around what I’ve variously described as the “science fiction” scenario (in which Trump simply seizes power) are viewed as wholly far-fetched.

“We are seeing some traders interested in expressing a view which will profit if we get a cleaner and swifter election outcome before the Nov 20 expiration than is priced-in,” Nomura’s Charlie McElligott remarked on Thursday.

For their part, Morgan Stanley said the “pain trade” in vol is lower. “There is much to keep implied vols elevated,” the bank’s Phanikiran Naraparaju and Sheena Shah said Wednesday, flagging what they called a “rampant” second wave of the virus, the US election, and a possible no-deal Brexit. But Morgan “suspect[s] implied vols will struggle to resist the gravitational pull lower.” They’re recommending short vol trades almost across the board, via a variety of expressions in various assets from equities to FX to credit to oil to gold.

Separately, the bank’s Michael Zezas says investors should focus on the Senate, not Trump, given the president’s long odds.

“Control of the Senate will mean the difference between substantial fiscal expansion and fiscal gridlock,” he wrote this week, noting that rates and crude aren’t priced for a Democratic sweep and the read-through of such an outcome for reflationary fiscal policy.

“US elections are rightly gathering a lot of the market attention [and] most derivatives markets are incorporating a significant volatility premium around and even beyond the election date,” SocGen’s Vincent Cassot, Jitesh Kumar, and Gaurav Tiwari wrote, in their latest volatility outlook.

They call the risk of a disputed result “overstated although not null.” In SocGen’s view, “the most attractive option” for investors and traders is “to focus on a modest normalization of the volatility landscape, using VIX options.” For Cassot, Kumar, and Tiwari, an “earlier-than-expected election result could lead to a relief rally in markets and pressure on short-term volatility.”

If you ask Trump, things are going fine. On Wednesday evening, for example, he posted a panoramic picture on Twitter of Air Force One parked in front of an outdoor crowd next to a crane hoisting a giant flag.

As ever, you don’t want to laugh, because the country is in a severe socioeconomic crisis and if things were to go awry next month, an already bad situation could be made immeasurably worse. And yet, visuals like that one elicit almost involuntary chuckles, which double as fatalistic laments for the cheapening of America.

Commenting further on Trump’s chances, Morgan’s Zezas said “it would likely require a game-changing event, a polling error of unprecedented proportion, or possibly both” for the president to win.

Forgive me, but that’s just the kind of sure-footed prognosticating that has many folks (including investors and traders) so nervous.