The US election and trading: expect volatility, avoid predictions

Where US equity markets will be in November looks as uncertain as the result of the country’s fast approaching presidential election. History may repeat itself in the markets, but any uphill ride will be bumpy. 

US flag
Source: Bloomberg

Last week, Columbian President Juan Manuel Santos won the Nobel Prize for a peace deal his fellow citizens had rejected in a vote. A few months ago, Britain’s EU membership was rejected by its citizens in a vote. The year 2016 seems like the year of voting dangerously. It’s no wonder that, despite recent polls, some Americans (including this Chicagoan) are wondering what surprises the US election might yet hold.

In contrast, US investors seem not just unconcerned but almost unaware that an election is upcoming. Since mid-September, the four major US stock indices have been stuck in sideways wedge patterns straight out of a technical analysis textbook.

Wedged in and ready to bust out

Traders have got used to this volatile, rangebound price action — great for scalpers, but tough for those looking for long-term direction. The only good advice has been to focus on limiting risk and take profits sooner rather than later. Expecting to ride a long-term trend has been fruitless, even for those with deep pockets and the patience to gut out big drawdowns.

That may be changing. After the second presidential debate, a controversial video, and a new poll showing one candidate with an 11-point lead, the market on Monday poked up out of that wedge. And the Nasdaq 100, which often leads the other indexes, made a new high of 4893.76. However, like the election outcome, where the markets will be in November is far from certain. By Tuesday, concerns about quarterly earnings and the Federal Reserve pushed stocks down again, but an uptrend may be developing.

That doesn’t mean buy-and-hold is back. It just means short-sellers shouldn’t marry their positions and longs should not stay long for very long. Any uphill ride will be bumpy.

History may not be prologue this time

My friend Jeffrey Hirschberg edits the Stock Trader’s Almanac, which has tracked market patterns and tendencies since 1967. He’s the one who taught me about the patterns common to US election years, like the lull in September and the rally that commonly follows Election Day. We saw the former and may yet see the latter.

That post-election rally isn’t necessarily an endorsement of the winner. Investors are often just relieved that the inexplicably long US campaign is over and we can resume our normal partisan gridlock. This year, though, forecasters have openly stated that one candidate’s victory might cause a drop in equities and surge in the dollar versus other currencies. The Mexican peso, for example, appears to be closely tracking the candidates’ poll numbers.

It was to Jeff that I first put forth my theory that July dips precede October drops. He agreed; the historical charts support it, even in some election years. But a corollary is that when July is good, October tends to be as well — and this year, July was pretty good. Last April, using old-school technicals like Fibonacci and trendlines, I predicted we’d see 2200 in the S&P 500 by mid-October. I stand by that prediction, but I’m a little shaky. When I made it, I didn’t see Brexit coming, nor did I see a certain candidate and an election season like this coming.

Bright outlook, dim view, and one sure thing

In the big picture, we’re still most likely to see a US stock market rally and a continuation of the economic policies that created it. But right now, why are Americans not happier about what, by the numbers anyway, are good times? President Obama made his case in The Economist:

'Despite all manner of division and discord, a second Great Depression was prevented. The financial system was stabilised without costing taxpayers a dime and the auto industry rescued. I enacted a larger and more front-loaded fiscal stimulus than even President Roosevelt’s New Deal and oversaw the most comprehensive rewriting of the rules of the financial system since the 1930s, as well as reforming health care and introducing new rules cutting emissions from vehicles and power plants.

The results are clear: a more durable, growing economy; 15m new private-sector jobs since early 2010; rising wages, falling poverty, and the beginnings of a reversal in inequality; 20m more Americans with health insurance, while health-care costs grow at the slowest rate in 50 years; annual deficits cut by nearly three-quarters; and declining carbon emissions.'

Not too shabby, considering where we were in 2008. In a sane election, the question would be, 'shall we carry on doing this or try something else?' And there would be thoughtful cases for both choices.

We may yet get the sane question and, in spite of the sound and fury (and video), a thoughtful reply from a resiliently optimistic American people. This American’s resiliently optimistic prediction, for what it’s worth, is 2200 and 45. 2200 in the S&P 500 before the month is out (but be prepared to short a drop to 2000). And a 45th president who will work for shared prosperity and not more inequality, whatever her (or his) party.  

But like the election, expect the road to that outcome to have some big potholes — big enough to hold a Wells Fargo armored car. The only sure thing this fall is volatility. I’m referring to the markets now, not candidates. Volatility is opportunity, for traders who can limit their risk using binary options or other methods. If only there were a way to guarantee limited risk in politics. 

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