MW The U.S. election need not be scary. History shows this is the way to trade it, says Citi.
By Jamie Chisholm
The S&P 500 looks well set for the rest of the year but there's also a way to gain from short-term volatility
You can feel the nerves. Just the next five trading sessions will see the monthly U.S. nonfarm payrolls report, the U.S. election, and a Federal Reserve policy decision. Investors have also become wary about some mega-tech company valuations.
The anxiety could be seen in Thursday's 1.9% drop for the S&P 500 SPX, which ensured the benchmark stock index broke a five month winning streak. Meanwhile, the CBOE VIX VIX, a measure of expected stock market volatility, is 22.5 and higher than the front-month VIX future at 20.6.
"The VIX term structure is inverted and is staying inverted past election day...This implies markets expect larger volatility moves near-term," says Tom Lee, head of research at Fundstrat.
Despite all this angst, a team of strategists at Citi led led by Dirk Willer believe the S&P 500 index is looking good into the year end.
They have taken profits on some of what they call their Trump trades - such as being long 5-year breakevens (betting on higher inflation) and being underweight European stocks versus the U.S. - because they feel that given the election is still to close to call the "risk-reward has deteriorated."
However, seasonal factors still support stocks of course, says Citi: "Years that have seen large returns in the S&P 500 from January - October have typically been followed by strong November-December returns. This is also true during election years." The S&P 500 is up 19.6% so far in 2024.
The Citi team also think the election in the medium term would have little impact. First, if Donald Trump regained the White House the stock market would shrug off concerns about his proposed tariffs on imports because it would be seen as a negotiating tactic and would not be swiftly implemented.
"Second, as we have written before, we do not see a Harris win, without carrying the Senate, as a big equity negative...Any Harris-related dip may be relatively short lived," says Citi.
As for interest rates, Citi says that monthly rises between 30 and 40 basis points on benchmark Treasury yields come with a positive median S&P 500 return, though stocks' return is negative for a 40-50 basis point increase. "This would suggest that a 10-year yield in the 4.50% to 4.70% range may still be consistent with a year-end [stock] rally, though much higher rates may not be," says Citi.
Furthermore, Citi says its variance risk premium has been triggered. This occurs when the spread between implied and realized volatility is greater than two standard deviations, and as the chart below shows it can be used as a contrarian indicator.
"While there is good reason for increased uncertainty ahead of the U.S. election, the market is showing signs of being 'overly fearful' and looks ready to bounce on a positive election outcome," says Citi.
But what about speculating on the election for the very short-term? Citi back tested how a range of assets performed over a 5, 10 and 22-day period if a trader had followed momentum after the Tuesday vote. In other words if an asset rose on the Wednesday the trader would buy it on the Thursday, and if it fell they would go short.
Of the assets they looked at, Citi's favorite candidate for chasing post-election momentum is the S&P 500. "Results for this are remarkable; even excluding 2008 (where the strategy would have correctly sold SPX), historically chasing momentum for 5 days following the election would have yielded an active information ratio of 6," says Citi. (The AIR is is a performance metric that compares the active return of an investment to its active risk, with a higher number being better).
"This is disconcertingly high, so for a robustness check we test the signal across multiple lags, finding that for short holding periods this remains a highly effective trading strategy. As such, we intend to look for opportunities to tactically chase SPX following price action next Wednesday," Citi concludes.
Markets
U.S. stock-index futures (ES00) (YM00) (NQ00) are higher early Friday as benchmark Treasury yields BX:TMUBMUSD10Y inch up. The dollar index DXY is higher, while oil prices (CL.1) are rising and gold (GC00) is trading around $2,753 an ounce.
Key asset performance Last 5d 1m YTD 1y S&P 500 5705.45 -1.80% 0.10% 19.62% 32.14% Nasdaq Composite 18,095.15 -1.74% 0.99% 20.54% 36.11% 10-year Treasury 4.299 5.30 33.70 41.81 -21.98 Gold 2760.3 -0.02% 3.26% 33.23% 38.02% Oil 71.24 -0.63% -4.31% -0.13% -11.93% Data: MarketWatch. Treasury yields change expressed in basis points
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The buzz
The October nonfarm payrolls report will be published at 8:30 a.m. Eastern. Economists forecast that a net 11,000 jobs were added, down from 254,000 in September. The unemployment rate is expected to remain at 4.1%, while month-on-month hourly wages will grow 0.3% against 0.4% in September.
Other U.S. economic data due on Friday include the S&P final manufacturing PMI for October, released at 9:45 a.m., and construction spending for September alongside ISM manufacturing for October, both published at 10:00 a.m.
Shares of Apple $(AAPL)$ are lower in premarket action, but those of Amazon.com $(AMZN)$ are higher as investors react to earnings late Thursday. Intel shares $(INTC)$ are surging 7% after giving upbeat forecasts.
Abbott Laboratories $(ABT)$ and Reckitt Benckiser (UK:RKT) shares are surging after a Missouri court ruled in the two companies' favor in a dispute over their specialist infant formulas.
Companies reporting earnings before the opening bell include Chevron $(CVX)$, Exxon Mobil $(XOM)$, Wayfair (W) and Dominion Energy $(D)$.
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The chart
It's difficult to gauge the Treasury term premium, which in very simple terms is the extra yield investors require for holding longer-term bonds. But this measure provided by Afonso Peccatiello at The Macro Compass blog shows it at the highest level in 10-years.
"Investors are less confident about a future of predictably contained inflation and growth, and they expect some more volatility and uncertainty down the road," says Peccatiello
"As we approach U.S. elections, bond markets are telling us - yes, 'this time is different'. Persistent fiscal deficits regardless of who wins U.S. elections can lead to more volatile inflation backdrops, and to more boom/bust cycles," he adds.
Top tickers
Here were the most active stock-market tickers on MarketWatch as of 6 a.m. Eastern.
Ticker Security name NVDA Nvidia TSLA Tesla AMZN Amazon.com DJT Trump Media & Technology AAPL Apple GME GameStop INTC Intel SMCI Super Micro Computer MSFT Microsoft TSM Taiwan Semiconductor Manufacturing
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-Jamie Chisholm
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(END) Dow Jones Newswires
November 01, 2024 06:30 ET (10:30 GMT)
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