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US Election : polls results remain highly volatile...

07 November 2016

...leading to market stress. Overall macro data was good during this eventful week: manufacturing indexes in line in the US, on a solid trend in China, same in Europe. Unemployment was in line in the US with rising wage growth and US GDP was above expectations.

On the micro front, earnings season keeps it trend : it is a positive one, earnings beat more than they usually do.

But the key topic is clearly not there: markets are only moving in tandem with polls and newsflows related to US elections. Trump is getting stronger in polls, the probability to see him in the White House has gone (if we trust polls institutes) from 13% at the end of October to 33% today, and markets are under renewed pressure: equities are down, dollar is weaker vs G3, peripheral spreads are widening, etc. however moves are not violent yet, markets are falling slowly with – rare thing to note – 8 consecutive negative trading days in S&P 500.In this kind of environment, like Brexit or some other political event, we must analyze things with cold blood:

  • Markets are unable to price political risk properly
  • During binary events, adjustments are made very rapidly
  • Markets reaction over the next 2-3 days is not always coherent with what happens over the next weeks
  • Lastly, we must take into account market technical at the time of the event.

So, what does this analysis suggests?1. First, investors are today positioned lightly in terms of risk taking. US elections are top of the mind for a long time and everyone remembers Brexit acutely. So everyone is prepared, with light equity exposures, etc. For illustrative purposes, please find below a US risk indicator that mirrors the other indicators we look at (RSI close to 30, very low equity ownership, negative flow in equities, etc.)2. Then, macro and micro backdrop is getting better, which is in first sight positive for risky assets3. Markets will probably slump if Trump is elected, because this is the way they operate, previsions are self-fulfilling and this would provide great entry pointsSo the idea is to go into the event with a portfolio light enough to take the opportunity to buy on the cheap in case Trump gets into the White House, but still with some risk on because we feel compensated for it today.

We have begun to move our books to take this scenario into account in switching our futures to options in delta equivalent. This enables to reduce significantly losses if markets collapse while enduring modest loss if Clinton gets elected. Apart from this move, we have not changed the portfolio radically: we have just take some profits on short dollar trades vs Euro and Yen that had done well.One thing that seems very clear to us is that we will increase risk post elections.

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