Election Trend Trades Take Off

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For months, traders have been focused on the potential for the election to lead to a burst of volatility in the markets, followed by clarity on which political party would steer fiscal policy for the foreseeable future.

The election didn’t disappoint.

Election reaction moves in many markets were the biggest in years, and the gauge of expected future volatility (VIX) collapsed, suggesting that traders and investors were pleasantly surprised at how quickly and orderly the election was decided.

What’s Next?

In this week’s Market Outlook, I’m going to look at the market with a simple method for listening to what the market is suggesting the future holds.

This week’s objective is to identify emerging major trends that are grounded in fundamental shifts that often occur after elections.

The premise of this method is that after a significant market event or catalyst, the behavior of new major market trends will follow this pattern:

1. The initial reaction to the catalyst will identify trends that will likely continue to be in play for several weeks or months.
2. The range of the initial market reaction can be used to identify when specific trends are likely to experience significant moves.

In the case of an election catalyst, the best ones begin with a significant initial reaction in the market.

While I do believe that the long-term (monthly) trends that follow the election catalyst will be fundamentally driven by the expectation and realization of earnings growth, the short and intermediate-term trends will also be determined by factors such as expectations of interest rates affecting growth, sentiment and positioning of investors, investor acceptance of valuation, liquidity, the existence of alternative investments, and more.

Unfortunately, predicting how all these factors will impact a trend is complicated.

However, the market’s price action defined by the Election Range can provide your answer or “prediction” in a way that doesn’t have to be complicated.

Unlike most of the statistics you’ll read in the reporting of last week’s price action, we’re going to look at the election price action from three perspectives:

The Initial Reaction

The initial reaction by markets to the election last week, as defined by the moves on the day following the decision of the election, was historically large and broad based.

The Election Range

The simple range to watch is that of the day after the election decision, Wednesday, Nov. 6^th. The more comprehensive range includes the election day.

The “Predictable Trends”

The most reliable trends to follow are the ones that move out of the range in a meaningful way in November. While they can consolidate for a short period, the best trends to consider trading as part of the election catalyst are those that start to trend sooner rather than later.

In the chart below, you’ll see the performance of the universe of assets and market sectors we’ll use to determine the markets’ message.

As I said above, we’re going to look at it in three time frames.

1. Election day (blue)
2. The Initial Reaction: The day after the election was decided (red), and
3. The Follow Through: The performance after the initial reaction, on the last two days of the week (yellow).

This view provides an overview of how domestically focused asset classes and sectors have traded around the election.

The chart is ordered by the size of the reaction day (red).

While it’s tempting to focus on the biggest moves, the more interesting insights and trading opportunities are in the details.

General Observations

• On election day (blue), before the winner was determined, the trend in almost every category was bullish.
• Almost all of the categories that had a negative reaction (red) have a significant correlation with interest rates. TLT (bonds) fell sharply, which means long-term interest rates rose. This explains why the housing and real estate sectors would have a negative initial reaction.
• Gold and silver weakness can be attributed to both higher rates and a decrease in uncertainty related to an orderly election outcome.
• Solar energy’s weakness is a function of President Trump’s well known desire to implement policies that will not be favorable to this sector.

Market Indexes, Bonds & Bitcoin

• As mentioned above, equity indexes maintained a very bullish reaction in the face of significantly higher rates. Typically, significant up moves in interest rates have a bearish impact on stocks unless the rise in rates is a result of expectations of significantly stronger economic or earnings growth prospects. The market will be weighing the belief in growth friendly fiscal policy vs. higher rates if bonds continue to fall.
• On Thursday, bonds rallied when the Fed cut rates, as expected. This may have supported the follow through higher in equities and bitcoin.
• Bitcoin’s explosive move could represent the beginning of new leg up in the large cap crypto currencies which have been consolidating for several months.

The S&P 500 Sectors

The table below organizes the sectors in the S&P 500 into categories that represent growth, investor’s risk appetite, cyclical, and financial bias.

• Grow focused sectors were the clear winners. Risk-On sectors continued to rally after the initial reaction. This is the most bullish pattern.
• Cyclically focused sectors had a strong reaction and then paused.
• Defensively focused sectors sold off after the election but turned up later in the week.
• Financial sectors were mixed, but generally bullish by the end of the week, helped by the reversal in the TLT.

The patterns in the price action by sector category illustrate the growth vs. interest rates debate that is likely to continue to drive sector rotation and strength of the market into the new year.

This suggests that rates are likely at a level that could hinder risk-on rallies if bonds continue to fall. However, if bonds stabilize or bounce back without fears of slowing growth, the bullish trends appear to be broadly in place across most sectors.

The Election Range Breakout

While rising interest rates appear to be a headwind for stocks, any market, sector, or stock that breaks out of its election range during November could be considered a trend capable of rallying through such headwinds.

Below is a chart of the markets and sectors covered in this article with charts illustrating the magnitude of any election range breakouts.

Tracking election range breakouts will provide a measure of the market’s breadth, insight into any emerging trends resulting from the upcoming change in the administration, and more.

The early breakouts have also historically provided opportunities for good swing trades into the end of the year and beyond.

For more information on trading election ranges, contact [email protected], download our free report on trading opportunities related to the election, or watch this recent webinar on trading election ranges.

 

 

 

Every week we review the big picture of the market's technical condition as seen through the lens of our Big View data charts. The bullets provide a quick summary organized by conditions we see as being risk-on, risk-off, or neutral.  The video analysis dives deeper.

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Risk On

• All four indexes exploded to new highs after the election and looks to be entering parabolic phases. Market action seems very bullish though some caution is warranted as both Real Motion and Price are outside their upper bands and showing an overbought condition. (+)
• Volume patterns are lagging a bit behind the market price action though still strong with more accumulation days than distribution days. (+)
• With the exception of Gold Miners, all sectors were up on the week led by regional banks and consumer discretionary, both quite bullish for the market and a positive sign for the U.S. economy. (+)
• There was considerable strength in small caps post election while foreign equities got hit hard showing the initial reaction to the Trump election, at least at first blush, was extremely positive.(+)
• Market internals that were looking marginal before the election are confirming the new all-time highs in the market, a bullish indication. Same for Nasdaq and S&P. (+)
• The NYSE New High New Low ratio flipped positive, confirming price action. (+)
• Both value and growth are in bull phases, though growth is now significantly outperforming value on both short and longer time frames. (+)
• The Modern Family, one of the better indicators for looking at the internal strength of the U.S. economy, is lagging a bit with only four out of the six members on new 2024 highs. Semiconductors are still lagging their July highs and Granny Retail (XRT) still needs to clear $80 for a full confirmation. (+)
• Bitcoin hit new all-time highs post election, with a lot of speculative inflows into the crypto and the new ETFs. (+)
• The U.S. dollar jumped after the election which seems like a positive for U.S. equities. (+)
• The FED raised interest rates by 0.25 basis points. After an initial jump after the election, rates settled-in unchanged on the week. (=)

Neutral

• Volatility remains elevated above its lowest levels in mid-May through July and look a little oversold on a short-term reading. (=)
• The number of stocks above their key moving averages is giving a neutral to negative read on balance across the Nasdaq, the S&P, and the Dow on all time frames. (=)
• Emerging markets snf larger cap foreign equities are severely lagging U.S. markets. Both EEM and EFA closed under key moving averages. (=)
• Gold is mean reverting from its recent new all-time highs at the end of October. Needs to hold its 50-Day Moving Average to keep its trend intact. (=)

Risk Off

• (none)