From Options to Inflation: Trading Strategies in the Context of Elections.

As the elections approach, the trading department at Goldman Sachs notes that clients are positioning themselves for various outcomes using options, considering there will be a binary result.

Goldman Sachs analyst Luis Miller notes that with only two weeks remaining until the elections, we see that the focus of clients is increasingly shifting toward different outcomes. The market is moving in the direction of a Republican victory.

However, Miller notes that today we are starting to see some cooling in pre-trading, with clients’ questions turning toward:

“Is a Republican victory really good for the market?”

“Is there anything that works for both candidates?”

and “What is the best way to play the tightening chances of the elections next week?”

“Is a Republican victory really good for the market?”
The markets may rise on news of a Republican success, as interest rates fall, since nominal and real GDP are above trend, which is not negative for stocks in the long run.

True inflation, which is not tied to wages or housing construction, is needed to be a problem for consumers. However, the rate of change matters.

A movement of 2 standard deviations in interest rates is 60 basis points and is historically negative for stocks. Over the last month, we have moved about 40 basis points, and our head of US interest rate products and co-chair of global rates trading, Anshul Segal, notes that the market is pricing a balance movement of 20 basis points during the elections.

“From a thematic perspective, our Republican pair has traded pro-cyclically; we can see an increase in quality (less Russell 2000 and regional banks, more high-quality cyclical assets and/or our standard Republican basket).”

It is worth noting that the rate-sensitive Wolfe pair (GSPU10YR Index) has reacted in line with interest rates, while the quality baskets of interest rate movements, as the market prices a result similar to that of 2016.

“Is there anything that works for both candidates?”
We like the exposure to small business (GSXUSMBB Index) compared to the broader market.

Simply put, removing the influence of the elections should help.

Both candidates seem to be interested in small businesses, with a potential $50,000 tax credit for new businesses proposed by Vice President Kamala Harris (depending on parliamentary majorities) or the deregulation program of former President Trump, along with potentially lower corporate taxes that could help boost sentiment (also depending on the ability to confirm their cabinet and regulatory appointments/parliamentary majorities).

A drop in short-term interest rates could be beneficial for improving the depressed sentiment of small businesses, and the valuation of this basket reflects that pessimism.

What is the best way to play the tightening chances of the elections next week?
To address the last question, Goldman created the GSCBDMRN index. This is a basket for renewable sources that is directly aimed at tracking Harris’s odds in predictive markets.

And finally, while all these tactical trades are based on betting on binary outcomes, no one but Paul Tudor Jones sees a much more strategic trading approach that is increasingly inevitable, regardless of who wins.

“What works, no matter who wins…?”
Reflecting on Japan’s experience and the current fiscal crisis in Washington (and in many of the western economies, based on the latest warnings from the IMF), Tudor Jones warns: “The game of getting out of this situation is inflation…”

How is he positioning for this?

“I think all roads lead to inflation. I’m long gold in the long run. I’m long Bitcoin in the long run. I think commodities are so crazily undervalued, so I’m long commodities in the long run. I think most young people find their hedge against inflation through Nasdaq, which is also great… I wouldn’t own any fixed income.”