It is that time again. A general election is ramping up and one of the questions that is most frequently asked is, “What can be expected from the market during and after the election?”
During most election cycles the answer would be; ‘that depends on what kind of trader or investor you are.’ For instance, if you are a buy and hold kind of investor, then typically the market doesn’t care which person ascends to the white house or stays. Historical averages show that the year proceeding a general election is overall bullish.
If, however, you were a swing trader or day trader then the reaction would be to warn that the market generally sees a little bit of a shake-up in the late September through mid-November months, probably due to a reshuffling of sector assets in large portfolios depending on whether the incoming administration is expected to be more oil friendly or eco-friendly or the like in their stated agenda.
Under those circumstances it is advised to watch the charts and be prepared to short start at the end of September.
It is not certain that the situation that America is facing is a typical general election. As there are always exceptions to the rule, 2008 was an exception where this general advice would not have served the buy and hold investors but would have worked brilliantly for the swing and day traders.
Here are the abnormal factors that have to be considered for this election cycle: all-time highs in the stock market indices, economic recession with slower than expected recovery, COVID-19 uncertainty, high unemployment, deep social unrest and probable higher than normal inflation.
Some of these are just general fears that can be put to bed because they will likely not affect the market much. For instance, social unrest is not likely at this point to cause a lot of market disruption since the rioting and other issues have been localized and not pointed at any specific market sector or company.
Also, it can be estimated that the inflation coming from the glut in money printing due to the stimulus over the last few months will not be truly felt in the market until the country starts to get back to something resembling normal. This idea of normal is unlikely to happen before mid-November at the earliest (vaccine estimates, or political factors considered). This is because inflation is dependent upon not only the supply of money but also what economists call the velocity of money, which has been abnormally slow during this lockdown.
Now educated guesses can be made about the other factors that cannot be put to rest. It is safe to say that individual stocks will continue to be affected by COVID-19 uncertainty. It is likely that this factor, when considered alone will continue to positively affect the tech stocks and negatively affect retail and retail dependent industrials.
The current recession on the other hand is a bit more muddled. On one hand, the stock market has ignored the economy thus far, could it continue? Well, it could, but history does not favor that as the most probable outcome. Historically, the stock market sooner or later reflects the state of the economy. This is because a stock as an asset has an intrinsic price that is tied to the value of the company’s estimated future net worth divided by the number of stock certificates issued. Given the reality of the current situation, most would agree that the current prices of many stocks contributing to the present market run-up is a bit overvalued. We can then deduce that one of two things will happen. Either the economy will make a V-shaped recovery, or the market will, at some point, come back down to earth, closer to true value of the individual stocks that comprise the market.
The extent of that correction, the type of correction (economy or stock market) and the timing of it is anyone’s guess but it can be assumed that it is more of an eventuality than anything else.
With that in mind, it is no wonder that a lot of angst exists among the more sophisticated investors about what to do and where to go with their money in these present circumstances. In fact, a recent article by Brian Sozzi published on Yahoo Finance reported that one of his sources, Tiger 21 a membership base organization comprised of wealthy investors, disclosed that the results of a recent survey showed that 62.6 percent of its members have dramatically increased their cash reserves in the last three months. These cash reserves are not indicating any anxiety with regard to inflation but are speaking volumes about the expectations of the near-term future of the market.
Some of the answer as to whether the market will crash down or the economy will V-shape up will depend greatly on how the government and Federal Reserve handles the backlog of home foreclosures that this coronavirus shutdown has occasioned in conjunction with how quickly the Federal Reserve pushes money to the banks that will be also be hit with the losses generated by the default in loans extended to main street small businesses as they declare bankruptcy, which is now happening at an accelerated rate. If these two things are not handled carefully then the credit crunch that follows will certainly have the same effect on the markets that it has in every deep recession before. Which is to say, bad and deep recession seen in the stock market.
So, what can be done about this? Some of the answer has to do with more ‘what you know’ than what you expect. The position here must be one of both protection against a sizable correction while giving your money a chance to capture at least some of the bull market momentum. For example, Online Trading Academy teaches the strategy of buying the indexes while the market is going up and at the same time insuring against losses in those index holdings using put options. This allows the investor to not only take advantage of the upward momentum of the market and insure against a drop but also allows added income from selling off the unused option puts if handled well. This has proven to be a very effective technique and is probably one of the more certain strategies for the upcoming months of political uncertainty.
Aaron Warby is the owner of Online Trading Academy.
