How to Trade the U.S. Election

  • US election tomorrow, Tuesday 8th November 2016.
  • Volatility is high, bear this in mind when trading.
  • Four asset classes: Equities, Fixed-Income, Currency, Commodities.
  • Article focused on Trump victory and short term view. For Clinton trades… well it’s going to basically be the reverse.

Tuesday 8th November the U.S. election will get underway. By 11pm ET, 4am GMT, we’ll have a pretty good understanding of who is the next leader of the Free World.

So, how do you trade the markets around this election date?

I firstly suggest that you don’t. Volatility is very high; the VIX – an index that tracks market volatility – is near 20. This is consistent with the levels seen during BREXIT in June and the Chinese slowdown blip in January, and indicates that the markets are rapidly oscillating.

If you’re absolutely certain you want to risk a little and make some green, below may help. I’m focusing on Trump because the scenario offers greater potentials for profits. The current market ‘base case’ (analyst term for – what we think is going to happen) is a Clinton win. Therefore a Trump win is not as priced into the markets and offers an added ‘upset market’ premium.

Side note: The Financial Times is offering free coverage of the US Election from tomorrow morning 10am GMT. FT.com/uselection.

Trump wins

A straight bet on Trump winning pays about 4/1. Binary options, such as IG.com, offer this sort of payout and opportunity. £20 pays out £100 incl. original £20.

Equities

The S&P500, the U.S. market index, just had the worst 9 day streak since 2011. Why? Since the FBI investigation re-opened over Hillary’s use of a private email server the markets have begun pricing in a Trump victory. This is not necessarily because a Trump victory is ‘bad’ for stocks, but because there will be a lot of uncertainty regarding his policies and the future of the government. A republican sweep of congress, senate and presidency will likely add to this uncertainty, as Trump will actually be able to invoke some of his presidential power. The markets are first-rate fan boys for the status quo; a sweep would blow this out the water. However after the memo came out yesterday regarding the FBI ending investigations into Clinton, the S&P500 has rallied 1.9%. These movements indicate our first trade. You’re going to want to go short S&P500.

 

sp
Despite a 1.9% rally today the S&P500 is still down -0.16% on the week over fear of Trump win.

 

There are also some more nuanced trades out there, such as going long on defence (i.e. military), which may perform well on Trump’s pro-defense stance, and long on pharmaceuticals, as fears of a Clinton administration imposing stricter laws on their monopolistic drug-selling policy will dissipate. A more protectionist-anti-trade political environment may also boost small cap companies.

The trade: Short S&P500, Long defence and pharma.

Fixed-Income

Fixed-income, i.e. the bond market, is going through a rough patch at the moment. The chart below shows that the US 10 yr Treasury yield has increased from approx. 1.70% at the beginning of the October to highs of 1.85%. Just today the yield has jumped between 1.80 – 1.83.

 

US 10 year Treasury - one month performance
US 10 year Treasury – one month performance

 

I would expect to see the treasury yield rise further on a Trump victory. This is based off both an uncertain economic environment reducing the willingness of investors to bet on U.S. government debt, and also Trump’s focus on increasing fiscal expenditure – which will raise the likelihood of a budget deficit. Both these factors, in my opinion, will cause investors to sell treasuries, decreasing price and increasing yield. This is coupled with an expected Fed rate rise in December, which will further depress treasury prices.

Safe haven government bonds, such as UK Gilts and German Bunds may be more attractive following a Trump win.

The trade: Long safe haven bonds UK Gilts, German Bunds. Short Treasuries.

Currency

The main currency building up to the election has been the Mexican peso. It’s become somewhat of a proxy for a Trump victory, as it is presumed his Presidency will be destructive for Mexican/U.S. relations. The MXN has devalued every time Trump pulls ahead in the polls, with the chart below demonstrating that relationship. Since the FBI investigation reopened, the USD against the MXN has strengthened (i.e. the peso has weakened), and since it closed the MXN has gained some serious ground (it may seem counterintuitive, but a MXN strengthen is seen by a fall in the graph).

USD/MSN from Oct 7th to Nov 7th
USD/MSN from Oct 7th to Nov 7th

 

The dollar is slightly harder to read; increased fiscal spending and a likely Fed hike in December could be beneficial for the currency, in terms of a stronger U.S. economy. However in the immediate aftermath it will likely devalue, for similar reasons to the S&P500 – uncertainty.

As for long positions, Japanese Yen’s status as a safe haven currency makes it the long target here. Similar to the S&P500 we’ve seen strengthening of the Yen over the past week, however the big jump today is indicative of a weaker Yen in anticipation of a Clinton win.

 

jpy
JPY over the past week 1st Nov to 7th Nov.

 

The trade: Short MXN, Long JPY.

Commodities

Gold is the go-to asset in times of uncertainty, fear, or upward spiraling inflation. If Trump wins we’ll see investors piling out of U.S. equities to put their money into this perceived safe haven.

Gold performance over past month.
Gold performance over past month.

The asset rallied throughout October and beginning of November as a Trump win increased in odds, however it has already lost about $30 from $1,300 to $1,270  following the FBI memo.

The trade: Long Gold.

 

My view

We shouldn’t underestimate the probability of Trump win. There is a lot of unheard discontent in the American populace, indeed globally, and if BREXIT has taught us anything it is to not trust the polls. If he does win, be very careful waking up on the 5th November. It will be tempting to go in for a few shorts, but the volatility is likely to be quite intense. You may easily find you’re on the wrong side of a quite rational trade, and losing money. Also bear in mind that the result is binary, so if you place a trade pre-Election and you’re on the wrong side you will lose a lot, fast.

Regardless of whether you decide to trade or not, I encourage you to take the time to follow the markets during and after the result. A Trump win will be the biggest market mover in a while (at least its short term movements) and in my eyes have a much greater effect than BREXIT.

-Ed

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