As you are aware, the US election is just around the corner and the market is beginning to reflect this in volatility. Volatility before an election is very common and we are seeing just that in the weeks leading up to a high-stakes election for both sides of the aisle. This can complicate the US stock market as both political parties outline their plans for the economy moving forward. However, regardless of what happens during this election, our portfolio needs to be ready to take advantage of the outcome, whatever that might be.
Currently, the biggest thing propping up the US stock market from downside volatility is the idea that the Speaker and the Treasury Secretary are getting close on stimulus. And even if stimulus does not come before the election, the market is pricing in that stimulus will come at some point. Should stimulus not get done prior to the election, the size and scale of stimulus will largely depend on the election outcome. There are many different outcome scenarios that the CEA team has taken into account when constructing our portfolio leading into the election.
The first outcome is some combination of gridlock inWashington. The market has historically done well in gridlock because the markets love certainty. Gridlock will result in very few different policies, tax plans, or regulations. Markets usually take the idea that nothing will get done in stride because there will likely be no curveballs to valuations.
Another outcome is a “blue wave”that many on Wall Street believe is being priced in. This outcome would lead to massive stimulus in the short-term and a sizable tax hike in the medium-term. The market would likely cheer the idea of a massive stimulus package being imminent during this outcome but would eventually need to discount whatever combination of corporate tax hikes and capital gains tax hikes we could see out of a blue sweep during election season.
The last outcome we could see is a wild Republican victory that would consist of retaining the Presidency and the Senate. Our team currently does not see a Red wave coming that takes back the House in addition to the GOP retaining the White House and the Senate. While anything is possible and we cannot rule this out, history tells us that this is unlikely to happen. Nonetheless, if the government maintains some version of its current self, the market would see this as an opportunity to continue enjoying the deregulation and tax cuts passed during President Trump’s first term.
All three outcomes I have outlined have spelled out a rather bullish case for the market, at least in the short-term after we know the election results. However, the key to that statement is when we know the election results. The markets hate uncertainty. There is nothing more we can learn from history than markets never trade upwards while there is tremendous uncertainty. Market’s do tend to rally after the uncertainty has been resolved and the degree of the rally largely depends on the degree of uncertainty.
This election could possibly set up some of the greatest uncertainty we have ever seen post-election while America awaits the outcome. We do not know when results will be finalized, if either party will concede should they lose, or whatever the outcome could be that leads to uncertainty. But the bottom-line is if the election is contested in anyway, there will be uncertainty. If there is a sweep for either side and the results don’t come down to waiting on certain states to finalize their mail-in tallies, then you could see the market trade upwards very soon after the election.
Because our team is wary of a contested election and what that could mean for our portfolio, we are going to raise at least 50% cash prior to the election. We have already raised 30% cash as of today, and plan on getting to 50% by trimming every day leading up to the last trading day of October. We believe that if there is volatility immediately after the election, we will be able to take advantage of such a situation with our cash. Additionally, if there is a clear winner immediately known to the markets soon after the election, we may allocate our cash swiftly.
Should our team decide to enter into a cash position larger than 50%, we may consider deploying an options position on the cash in excess of 50% so that we can participate in an immediate rally should there be one. And if there is not an immediate rally November 4th through the 6th, we will liquidate that options position.
Our team is more interested in preserving and protecting our investors’ capital entering into a volatile event such as this upcoming election rather than trying to participate in a day the market trades up a percent or two in the off chance there are immediate election results available to the public with no disruptive events.
CEA has never managed our portfolio based on who we think will win an election. Additionally, we have never tried to time the market or claimed we can time a market. What our team tries to do instead during times like these is take risk off the table when there is uncertainty. When the downside potential of the market doesn’t align with the upside premium baked into the market, we have historically raised large cash positions.
No one knows what the next few weeks will hold. Will we see a sweep for either side? Or will we have a contested election that leads to disruptive economic activity? No one knows and the CEA team does not know. But what we do know is the market is baking in extreme volatility in the options markets around the election date, on a market that is already trading at historically high multiples. During a time with what seems to be a COVID resurgence around the world, less confidence in the vaccine being a binary event, and a looming election process, raising cash is the prudent thing to do to protect the capital of the fund.