4 ways to help offset US election volatility

October 13, 20202 Comments

An uncontested election seems to be priced by the stock market…which is interesting when you consider that both sides (Trump/Biden) have stated they will contest a close election. A contested election would likely result in a short termed stock market selloff in early November. Thus, in my view, we should consider how we might manage risk going into November.

 

4 ideas to help offset election day risk

  1. EX-USA stocks: Global securities help you mitigate some risk on home soil. Some interesting plays to consider include Europe, Japan, and broad emerging markets with some extra exposure to areas benefitting from re-inflation due to concentration in mining, like Chile (disclosure: we own a Chile ETF and broad EM ETF). Some exposure to commodities like gold, silver, base metals make sense as part of your longer termed inflation protection. Canadian and Australian markets are also weighted reasonably high in these commodity producers.
  2. Cash: Clearly, a contested election might inspire a market selloff. You only get to buy cheap stocks in this environment if you have some cash on hand.
  3. Election Paired trade: Consider adding some out of favor securities to enable participation from either side of the election. One could do a “paired trade” holding an oversold sector for a Trump win, pitted against an oversold sector for a Biden win. One side will possibly rally hard, while the other side will possibly fall less due to the already oversold status of the sector.

For example, here is a paired trade we are considering for the ValueTrend Aggressive Growth Platform (not for the regular Equity Platform, which has a much more conservative mandate):

On the “Trump win” trade: energy is way out of favor and may be a contrarian trade (see my blog last week). Trump favors aiding the energy sector, including pipelines. Tax loss selling into late December may present an excellent capitulation trading opportunity in this sector.

On the “Biden win” trade: Cannabis – particularly Canadian operations- are oversold. Biden will push through a nation-wide cannabis legalization. Below is the Horizons HMMJ ETF. Its largely focused on Canadian marijuana stocks. Disclosure: we bought a position in this ETF in our Aggressive Growth Platform (not in our Conservative strategy).

  1. Volatility: This idea would only be appropriate for aggressive traders, but for those with the risk tolerance, volatility (playing the VIX, for example) is getting cheaper. Three weeks ago, the contested election scenario was consensus, NOW it has cheapened dramatically as the Street has nearly unanimously moved into the Biden win camp with no contest. This has improved the risk-reward dynamic in being long volatility into the election. Note the VIX chart below. New support (old resistance) lies near 20. Its about 26 right now. One could see it float in this 20-26 range for the next few weeks leading into the election. An election upset or contested election could easily see a spike to 33, and higher (such as the spike to 40 back in the early summer). So, the neartermed risk is to 20, and the neartermed reward is to 33 from here. That is nearly even for upside/downside, which is why we’ve only bought an initial position. But a move to 20 would likely inspire me to add more to our volatility hedge. I feel there is a good probability of a highly emotional market into November.

Note that a volatility play is a hedge, and nothing more. If there is no contested election, your volatility play will lose money…. quickly! But, if volatility spikes on an upset…the upside could be considerable enough to offset some of the losses of equities. Keep in mind that the VIX moves quickly – big spikes happen within one day. If it turns out to be a good, or a bad trade, you must move quickly to take profits or cut losses. I view this as a hedge, not an outright market play. As such, a loss on a volatility play will simply be the price I’ve paid to hedge against risk. If the volatility play does well, I expect that it will only help to offset some of the losses in my equity exposure. I don’t normally endorse an outright speculation on this type of instrument, nor would I suggest it as a long or even a mid-term hold. This is an election hedge to my mind. Nothing else.  Disclosure: we bought a small position in our Aggressive Platform in a VIX single (non leveraged) ETF last week, and may add to it.

 

Conclusion

While we have not added volatility to our conservative Equity Platform, we have added the other positions (international, re-inflation positions, cash) to both our Aggressive and Conservative Platforms. Hopefully, these ideas will give you food for thought for your portfolio strategies, in the context of your goals.

 

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