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Bet On Political Volatility And Market Stability

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Slow-moving coup.

It’s a term we have all heard. Comedian Bill Maher has repeatedly referenced it to admonish his viewers of Trump’s intention to stay in office even if he loses the election. They called him paranoid. But will he be vindicated?

Last week, Trump made statements that directly called into question the validity of our election process and did more than a hint that he may stay in office and fight the results. And if, for whatever reason, you disagree with that, we can all agree that there is s zero percent chance Trump would concede immediately following the election. Every vote will have to be counted and, even then, the chances this election ends up in the courts is high. No matter what happens, statements calling into question the integrity of our election process, especially in terms of mail-in voting, have placed a question mark on the outcome. That is just a non-partisan fact.

 And yet did the markets freak out? No, not really. Wild. And that is why there is a good argument to be made that expected market volatility is overblown.

These are Unique Times, Indeed.

Just imagine if the nation’s first first-term president John Adams even hinted at refusing to accept the results of his electoral defeat at the hands of Jefferson in 1800. When word spread by horseback to the far reaches of the colonies, the budding nation, and its incipient decade stock exchange, would have died in their cribs. The Buttonwood Tree Agreement would not have been worth the paper it was printed on and the sycamores themselves sold for scrap.

But today is a different story. One thing on which everyone agrees is that our democracy is broken. The final nail in the coffin came this week in the wake of RBG’s death and Senator Mitch McConnell’s brazen about-face on replacing a Supreme Court Justice during the final year of a president’s tenure. Just as no one was surprised by that, no one will be, nor should be, surprised by Trump’s refusal to leave; he has told us as much repeatedly. The slow-moving coup is about to speed up.

A report from The Atlantic claims Trump is looking to ensure that Republican electors vote not according to the popular vote in the state as is customary, but for him no matter what the ballot count winds up being. The nation’s Electoral College system depends on the votes of the 538 electors. There is nothing in the Constitution that says they must vote in accordance with the will of the people in their districts. Article II, Section 1, Clause 2 just says that each state shall appoint electors “In such Manner as the Legislature thereof may direct.”

Of course, this language was inserted as a way of protecting the nation from someone just like Trump, but that’s unfortunately besides the point. The forthcoming disaster will lead, if we survive, to an eradication of the Electoral College once and for all. In the framers’ desire to protect the minority from the masses, they failed to lay the groundwork to prevent the masses from the minority. Gerrymandering was just the beginning.

But who cares? Not the market. While there will be an uptick in the fear index, known as The CBOE Volatility Index (VIX), volatility won’t be near as severe or as long-lasting as most investors and analysts are counting on, should a contested election take place. There are several ways to bet on or against stock market turbulence.

While you cannot buy the VIX directly, you can buy through several ETNs, including Barclays iPath Series B S7P 500 VIX Short-Term Futures ETN (BATS: VXX).

Most investors are betting on it to rise; I am betting it will rise, but not as high as expected, and will fall faster than anticipated. And I am not alone. Why? Because the VIX is already priced at a historical premium. As likeminded contrarian Clifton Hill, global macro portfolio manager for Acadian Asset Management, told MarketWatch, volatility looks “expensive.” I agree.

But a contested election of this magnitude, a constitutional crisis of this scale? Doesn’t matter. We all know the market is, in large part, divorced from the economy, a lesson this year made abundantly clear. Yes, the market (or rather, slices of it) goes down a bit on bad unemployment or virus news, but the insane bull-run bounce-back after March that began to weaken in September did not rise or fall based on any major macroeconomic news.

Exuberance and earnings from tech giants overweight on indexes drove the stock rally to obscene heights. The market is divorced from the economy and economic uncertainty. We know that. So why shouldn’t it likewise be divorced, at least to a larger extent than is widely believed, from political uncertainty?

It’s all about sentiment. And the sentiment is that the market and the economy are distinct. So, too, is the sentiment that our democracy is broken. So, too, is the sentiment that economic performance trumps the rule of law or democratic norms.

I honestly believe that a large swath of the American public is ready for a dictator, so long as it is their dictator looking out for their interests.

This is not hyperbole. We have come to this point culturally due to a combination of privilege and paralysis in equal parts. Privilege, because we are the oldest continuing democracy in the world, an island free of a real constitutional crisis and the threat of foreign invasion, and paralysis because we are unable at this point in our history to enact major change.

We do not know what countries like Germany know—that democracy is fragile, and tyranny is but a half step behind, waiting patiently to pick up the broken pieces. Russians are cynical of their government because it never worked; we are cynical of ours because it has simultaneously worked too well and too little. Our government’s political stability has come at the expense of its competency. Even Eastern European nations have forgotten what dictatorship looks like as some turn their backs on their nascent democracies. In America, we have not outgrown our republic; it has outgrown us. Politicians always pander by saying we should have a government as good as our people. The way we are headed, we soon will.

The faith in our institutions is over, but the faith in our markets remains…for now.

And why not? China doesn’t have democracy and yet they build bridges while we build (or fail to build) walls. The theory was that, once rich, the Chinese would demand democracy. Well, they are rich (or rich enough), and they don’t seem to care. Perhaps we won’t either, so long as people get to keep their guns and the Academy of Motion Picture Arts and Sciences pushes for more diversity in directorial nominations.

A smart bet would be to bet against market volatility, a smarter one would be to bet on a political crisis unlike any our nation has known since the Civil War. If I find an index that bets on the end of our republic as we know it, I will let you know. Such an ETF would represent my most cynical, yet most confident “buy.”

Positions to Take in the VIX

Let me be clear: Volatility will rise during and after the election, especially if it is a contested one. Right now, November futures contracts tied to the VIX have been significantly lifted, which is typical. What is atypical is the fact that volatility futures prices are also up for December and January. Which, of course, speaks to the expectation of a contested election, images of Trump being forced out by the Secret Service by his “hair” no doubt dancing in traders’ heads.

But it is the very fact that this is expected leads me to believe the volatility will not be as significant as charts indicate. The VIX will, indeed, go up from where it is now, which is why you can buy it today and sell in November. This is a good hedge for the next trade, betting against the volatility investors seem to be betting on for December and January.

There are myriad ways to do it—from shorting the VIX outright to buying puts and selling calls. Obviously, selling options is generally riskier than buying them in terms of what you can lose, the former offering nearly infinite downside potential. While the buyer of options has the right, but not the obligation, to buy or sell an underlying security at a specified strike price, the seller is obligated to buy or sell an underlying security at a specified strike price if the buyer chooses to exercise the option. For every buyer, there needs to be a seller.

As for me, I will be buying puts; you should too.

You Could Also Bet on the Election

If you are confident in your pick, you can bet on all things political on sites like MyBookie.com, Bookies.com, Bovada.com, and BetOnline.com, to name a few. Today’s odds, according to Bookies.com, have Biden the favorite with -121 odds.

However, I do not see a bet for a contested election, or a bet that Trump will not leave office.

When I do, I will let it ride. All of it.

 

 

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