As the time before the elections is almost up, I believe that from now on we are entering an era of high volatility in the markets. Pre- election volatility is a common and normal phenomenon, especially in a year like this that we encountered tremendous ups and downs. After all, even the continuing rise of stocks is taking place with volatility indices remaining at higher levels than their long-term average.
This volatility period could last these 2 weeks before the elections or it could last a lot more depending on the elections’ result or possible destabilizing factors that elections may bring with them. All this could create conditions of intense instability since stocks have significantly rallied.
Furthermore, current period is corporate 3rd quarter’s results release period and there is always the possibility of a negative surprise. Lastly, the pandemic continues to attack fiercely all countries, resulting to a massive uneven fight the planet gives so as to avoid new horizontal lockdowns and limit any financial losses to local level.
All this, at a time when macroeconomic indicators are beginning to reveal strong signs of fatigue and companies that have been hit hard by the pandemic (airlines, restaurants, real estate, hotels, entertainment, cruises), having no other state aid funds, will be forced to make redundancies.
Given that before the election, as it became clear, there will be no deal on a new support package, this will be the first thing that the next President will do. But if the next President will not gather majority of elected representatives both in the Senate and in the House of Representatives, then this scenario will push stocks lower.
This is the main reason why I think that the post-election markets outlook may not be so clear, short- term speaking. That is why we need patience and liquidity to take advantage of every possible opportunity that could emerge in the markets.
The following graph presents Nasdaq’s volatility index in comparison to Nasdaq itself. It is obvious that we are caught in a situation, which is similar to the one that paved the ground for a long- term rally in 2009. This time, though, there is even greater momentum and even more market participants, and for this reason there is a steadily increasing volatility and steep movements.
For instance, it is remarkable that March’s rally joined many retail investors and only a few professionals, a unique phenomenon in markets’ history, because traditionally retail investors enter the market at its peak and very rarely at its bottom. Buying frenzy and the use of tools such as options make dealers take defensive positions, which means that they are forced to buy shares, as well as security in case market falls. Stocks as a result of options trading, security as a result of long exposure to stocks.
Smooth transition from President to President
Traditionally a President continues his term from where he had stopped, leading stocks higher or in case he is not reelected, the next President should take over and take advantage from the pre- existing trend.
Chart by Macrotrends.net
The above graph not only confirms what I am saying, but also keeps up hope for a more promising next term. There are two statistics that help draw this conclusion. First, a quadrennium which in its last year records losses of more than 30%, is followed by a significantly better year. Second, Democrats have far better returns in the markets. Since 1901, Dow Jones average profits during each presidential term amount to 92%, a percentage that is double that of the Republicans. And we shall not forget that the next President may claim unprecedented fiscal and monetary support.
There is a point I need to underline. In case Biden is elected, this could trigger volatility rise in the last quarter due to a crucial factor. The promise of tax increase. This affects big investors’ plans and portfolios, because they will be forced to readapt their portfolios for tax reasons.
It is common that they avoid selling stocks that have generated profits, for fear of being taxed, and liquidate losses so as to pay less in taxes. However, this year they are in front of a dilemma: if they keep the profits and tax increases, they will lose more. In addition, if they sell the loss-making sectors, they are likely to benefit from a possible Biden term.