Election Year Jitters: How to Navigate the Volatile US Equity MaUS Presidential Elections and US Equities are a match made in heaven. History shows that market swings more up than down. This year, prepare for a wild ride full of twists.
Sadly, former President Donald Trump was shot at a rally over the weekend. He survived and is safe. Investors are expected to shift into haven assets. Gold could test all-time highs. The Dollar, Yen and Bitcoin will rise.
WHAT IS THE US PRESIDENTIAL ELECTION CYCLE THEORY?
Yale Hirsch introduced this theory. It posits that stock markets are weakest in the year following Presidential elections. The presidential election impacts economic policies and consequently market sentiment. Theory suggests that US equities perform best during the third followed by the fourth year of a Presidential term.
In 1967, Yale Hirsch (a market researcher) published the first edition of the Stock Trader’s Almanac. According to the book, the President typically indulges the special interest group who got him elected in the first two years after assuming the office.
With the next election round the corner, the President shifts focus on shoring up the economy to get re-elected during the third and fourth year. Consequently, equities gain during the second half of the Presidential term.
That's the theory, but does it hold true? The answer turns out to be an emphatic yes.
S&P500 Index Performance since 1960 with election years highlighted
BUT HOW ABOUT SECOND HALF OF THE ELECTION YEAR?
With half of the election year behind us, crucially, how do markets perform during the second half of an election year?
Over the last 6 decades, the S&P500 on average delivered positive returns in 13 of the 16 election years during the second half of the year.
2008 was a washout year for equities with global financial crisis crushing equities. The S&P500 returns for the first half of election year was 4.1% followed by 3.2% in the second half on average even after including 2008.
S&P500 tends have positive bias in election years
Excluding 2008, average S&P500 returns for the first half of election year was 4.9% followed by 5.4% in the second half.
S&P500 positive bias during election years is even more pronounced when 2008 GFC abnormal returns are excluded
PAST RESULTS ARE NOT INDICATIVE OF FUTURE PERFORMANCE
History has shown time and again that timing the market is futile. Using Hirsch’s theory as gospel can be dangerous. Presidential elections occur once only every four years.
Even though the analysis above covers 6 decades, it only has 16 data points. By any measure, that's far too little to arrive at definitive conclusions.
As any sensible statistician would tell you, even if two variables are correlated (election cycle and S&P500), it does not guarantee causation.
WHAT CAN INVESTORS EXPECT DURING 2024 ELECTION YEAR?
It is not just historical precedent that suggests upside in the next six months, market conditions also suggest equities could see further upside.
2024 has been a stunning year. Gen AI frenzy has fuelled powerful rally. It has been the strongest tailwind since the dot-com mania. Unlike the dot-gone era, companies are producing eye-popping revenues and profits that support the rally.
The recession that never came has been a powerful tailwind that has helped equity markets soar to heights never seen before.
Inflation has been easing. Labour markets are tightening. Expectations of rate cuts are rising fast.
The next Fed meeting is scheduled on 31st July. Markets are pricing 93% chance of the Fed Fund rates remaining unchanged at the current 525-550 basis points (bps).
The picture is starkly different for the Fed meeting on 18th September. Markets are pricing >90% chance of the Fed starting to cut the rates by 25bps based on CME FedWatch tool as of close of markets on 12th July 2024.
Slowing economy and rising unemployment will trigger the Fed to commence its rate cutting cycle
Citi analysts predict that the Fed will slash rates by 200 bps (2% in total) by the summer of 2025. 25bps of rate cuts in eight successive meetings, starting in September. A slowing economy and growing unemployment are cited as the basis for this aggressive rate cut cycle.
RATE CUTS WILL PUT MARKETS ON TOP GEAR
Two active wars. Extreme weather conditions. Shocks from elections across the globe. None of these have had any dampening effect on equities. Such is the euphoria.
Rate cuts will put a turbo charged market on steroids. Investors out to be cautious to assess if rate cuts are already priced into equities given that S&P 500 is up >11% over last three months including 2.8% so far in July.
It is essential to make risk mitigated moves in the second half of an election year.
WHAT ALTERNATIVES DO INVESTORS HAVE?
There are many alternatives. Three common possibilities are (a) Long Micro E-Mini S&P 500 index futures, (b) Long call options on Micro E-Mini S&P 500 index futures, and (c) Bullish put spread on Micro E-Mini S&P 500 index futures.
Futures enable direct, liquid, and efficient access to the index.
Long call enables investors to gain from rising S&P 500 and from volatility expansion.
Bullish put spread allows the trader to harvest put options premium as the index rises. The bull put spread consists of one short put with a higher strike and one long put with a lower strike.
Given the sharp run-up in the index and expected volatility, long calls are not viable. Risk reward ratios for a bullish put are not compelling. Hence, a hypothetical trade set up using futures.
HYPOTHETICAL TRADE SETUP
With equity markets in euphoria and rate cuts expected starting in September, US equities are poised to rally further. Historical precedent shows that 2H of election years tends to results in positive returns in the S&P 500. Investors can express this view using Micro E-Mini S&P 500 Index futures.
Trade set up using Micro E-Mini S&P500 Index Futures expiring in Dec 2024 (MESZ2024) is summarised below:
• Entry: 5650
• Target: 6030
• Stoploss: 5400
• Profit at target: USD 1,900 (6030 – 5650 = 380 index points; Profit = 380 points x USD 5/point = USD 1,900)
• Loss at Stop: USD 1,250 (5400 – 5650 = 250 index points; Loss = 250 points x USD 5/point = USD 1,250)
• Reward to Risk: 1.5x
MARKET DATA
CME Real-time Market Data helps identify trading set-ups and express market views better. If you have futures in your trading portfolio, you can check out on CME Group data plans available that suit your trading needs www.tradingview.com
DISCLAIMER
This case study is for educational purposes only and does not constitute investment recommendations or advice. Nor are they used to promote any specific products, or services.
Trading or investment ideas cited here are for illustration only, as an integral part of a case study to demonstrate the fundamental concepts in risk management or trading under the market scenarios being discussed. Please read the FULL DISCLAIMER the link to which is provided in our profile description.
