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If you watched the presidential debate last Tuesday, you now have some idea of just how insane and unusual this election is going to be.
If you missed the debate, congratulations for sidestepping a train wreck.
We are not going to pick sides or tell you how to vote. That's a personal decision.
We need to address the fact that elections do have consequences, which can impact the financial markets.
There are five weeks left until the election. The noise level is going to go off the charts. If you live in a swing state, it might be a good idea to DVR your favorite shows so you can fast-forward through the barrage of political ads.
The election has not yet become a significant factor for a market still dealing with the pandemic and the U.S. Federal Reserve's actions.
With each passing day, traders will become more aware of how the election is shaping up and what that might mean for the economy. Each party has an agenda, and those agendas have possible consequences for the economy and the stock market.
The prevailing idea is that Republicans are good for the stock market, and the Democrats are bad. The historical data does not support that at all.
CFRA Research examined the performance of the market based on who lived at 1600 Pennsylvania Avenue. The found that since 1945, the S&P 500 has averaged an annual gain of 11.2% during years when Democrats occupied the White House compared to just 6.9% average gain under Republicans.
That's under normal conditions. Nothing is normal right now.
Corporate tax increases are on the table. The two parties have a wide difference in how they think we should deal with the pandemic's economic consequences. The composition of the Supreme Court is very much in play, and that could have long-term implications for corporate America.
In 2016, everyone thought they knew how the stock market would react no matter who was elected.
Everyone was wrong.
In the hours after Trump won the election, the markets did plunge as expected, but the atmosphere was much more upbeat by the next morning. It stayed upbeat until the coronavirus arrived on our shores back in March of this year.
There's no guarantee what the market will do post-election. But we do know that as we get closer, traders will pay more attention to how the results of Nov. 3 will affect the markets. The polls will begin to swing stock prices over the next month.
It is time to hedge our bets a little. We can track the rise of political unrest among traders by watching the VIX. We can use the VIX volatility measure level to determine how much of a hedge we should have in place to protect ourselves against a plunge.
The Long of It: Insurance in Inverse Funds
It's a good time to put money into an ETF that will skyrocket if the market plunges: the S&P 500 Proshares Short Inverse Fund (NYSEArca: SH). With the VIX at 26 right now, a good practice is to hedge 26% of your portfolio against election risk. That means for every dollar you have invested in stocks, you'd put $0.26 into SH. As the market falls, SH will rise and offset any losses in your portfolio.
Reset your exposure every week until the election is over.
If we do see a steep sell-off as a result of the election, I would stay hedged until the S&P 500 was 20% below the 200-day moving average or showed strong signs of recovering, which we'll keep you updated on. If your hedge dropped back to breakeven, I would close it out.
The Short of It: Playing Tech Short
If we look at the election's possible outcomes, the worst result would be a sweep of The White House, the Senate, and the House by either party.
There appears to be little chance of a GOP sweep, but a Democratic sweep is still in play.
That would mean increased corporate taxes, higher taxes for the wealthy, and a much less favorable regulatory environment of business.
A divided government like we have now with neither party in control means lots more rhetoric, but nothing passed unless the need is dire, as was the case with the first stimulus package.
A sweep could cause a sell-off.
A continued division may spark a relief rally.
The best play is a straddle. To put the trade on, make the market's volatility work for you to establish your position.
Buy a November Invesco QQQ Trust Series 1 (NASDAQ: QQQ) $300 call on a down day for $5 or less.
On the next up day, buy a November $250 put for $5 or less.
Keep the trade open until expiration unless one leg rises by 100%. If that happens, close that trade and take a free ride on a reversal.
We may not know the results of this election until December because of the pandemic-driven swell in mail-in votes.
What looks like a victory for one side may well turn into a defeat before this is all over.
And in the meantime, don't forget to check out my colleague Shah Gilani's latest stock-picking presentation…
You see, Money Morning has launched its first-ever stock-picking lightning round event. Our chief investment strategist flies through stocks – more than 50 – telling you which to consider buying NOW and which to drop like a ton of bricks.
These picks will be coming fast and furious, so you will want to take notes. Click here now to watch…
About the Author
Garrett Baldwin is a globally recognized research economist, financial writer, and consultant with degrees from Northwestern, Johns Hopkins, Purdue, and Indiana University. He is a seasoned financial and political risk analyst, with a focus on stocks, hedge funds, private equity, blockchain, and housing policy. He has conducted risk assessment projects for clients in 27 countries, and consulted on policy and financial operations for some of the nation's largest financial institutions, including a $1.5 trillion credit fund, a $43 billion credit and auto loan giant, as well as two of the largest Wall Street banks by assets under management.
Garrett joined Money Map Press as an economist and researcher in 2011, specializing in alternative strategies with an emphasis on fundamental and technical analysis.