This is Where the Market Could be Wrong

Is the Election Still a Possible Source of Surprise?

Staying with a bullish bias has been the right decision even with all the back and forth in the press regarding stimulus. I continue to view a deal before the election as a potential upside surprise, but not the base-case. This has me thinking about what are the consensus views in the market right now and where is the potential for surprise?

Clearly, the election is top of mind for the majority of the population, investors or otherwise. The simple fact is there is going to be roughly half the country who are disappointed by the result…if we get that result on election night or some later date remains to be seen. This actually gets to one of the areas of consensus that is on my mind.

Following the first (and only?) presidential debate, Biden’s lead widened in the polls and in the betting markets. According to PredictIt, Biden’s edge has narrowed a bit over the past day but he remains with a lead. I feel that the consensus view is becoming that Biden will have a large enough margin of victory on election night that even if Trump were to contest it (consensus is that he will) that no one, especially investors, will take Trump’s claims seriously. I think that this is a big reason that the S&P 500 broke out of the recent trading range that was capped on the upside near 3,430. If we know and accept who the winner is on election night, that will alleviate a big source of uncertainty.

The fact that this is becoming the consensus view does not make it wrong. It simply sets up a situation where if the election is close enough on November 3rd that Trump’s (or Biden’s if it goes that way) unwillingness to accept the result may be a bearish surprise. In fact, there may be reason to believe that the race will actually be closer than the betting markets and polls suggest. My friend Mike Kramer had this to say about it over the weekend:

Many of the polls currently show that President Donald Trump is losing by a relatively wide margin to the challenger, former VP Joe Biden, for the Presidential election. The latest average from the from RealClearPolitics shows that Joe Biden has a 9.6 percentage point lead over Trump. However, when running through some data and looking at things from a different perspective, we can find that the race may be much closer than those poles would suggest.

One project that I worked on starting in 2016, which proved to be a unique approach, was to use the Federal Election Commission donor data. I took the concept that a donation towards a candidate was the same as placing a bet or wager. As part of this process, I only looked for donations of $5 or more, and I removed all individual that donated more than once, so we all only get one vote.

Mike added a lot of extra data which suggest that there may be scope for the consensus view of a clear Biden win on election night to not be the slam dunk that is currently being priced in. Read the reset of his thoughts here.

Hand in hand with the trend toward a Biden win on election night becoming consensus, is the view that volatility has to decline. The chart from VIX Central has been making the rounds, with the pronounced hump in November because of the election uncertainty.

Interestingly, this “hump” was higher before Trump tested positive. It has come in as Biden’s lead has widened. So a falling VIX is a becoming a consensus view and investors are placing their bets in that direction, as Helene Meisler pointed out on Twitter. Again, I can’t say that the bets are wrong, only that there is potential for a surprise.

Next, the assumption is that a Biden win combined with a “Blue Wave” in the Senate will lead to large stimulus. My view is that we are going to get stimulus regardless of the winners and it is a matter of when, not if. The bigger issue is how much? If the consensus is correct, then it will likely be larger than what is being discussed now. Pelosi declined the recent $1.8 trillion Trump bid as she sits firmly atop her $2.2 trillion ask. The spread is narrowing but there is still no trade. In all honesty, if Pelosi thinks that the dems will win the White House and the Senate to go along with the House, why would she move? Why not hold out until January and work for something bigger?

Now, I am in the inflation camp but if the race for the White House is tighter than the market thinks then maybe the size of the ultimate package will be smaller than the market thinks. This would throw off the inflation bet a bit. The dollar would likely head higher, commodities would probably take a hit and the long-end of the curve would go bid.

In thinking about where the market could be wrong, these thoughts have been running through my head this weekend in between ballet classes and birthday parties. I am not saying that the market is wrong, just thinking about where the blind spots could be.