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S&P 500 and Dollar Forecast Leads Global Markets with Elections Expectations

S&P 500 and Dollar Forecast Leads Global Markets with Elections Expectations

2020-10-31 03:45:00
John Kicklighter, Chief Strategist
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Dollar, S&P 500, VIX Talking Points:

  • Risk benchmarks took a job lower this past week – a relief move before the upcoming US Presidential election
  • While the decision on the next President and composition of Congress can significantly alter the downstream economic forecast, the interest now is in anticipation
  • Whether or not we witness a contested US election is top market influence in my book, but the winner likely matters less than the other systemic themes waiting in the wings
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Risk trends slipped this past week leading some to read fear in the tea leaves for the forthcoming election volatility while others simply register a natural easing of risk exposure before a key event risk. I believe the ruling on this discrepancy in conviction will remain unclear until we actually traverse the critical event risk. Nevertheless, there was an unmistakable pullback in the benchmark risk measures like the S&P 500. The US equity index notched its biggest weekly decline since the height of the pandemic back in March. The slide was steep enough to quiet dip buys while still not stretching far enough to register a technical correction (a 10 percent retreat from highs). Now, we face two major questions: how will the US elections play out and was this retreat substantial enough to rouse enthusiasm for the unfalteringly opportunistic bulls to enter on a pullback?

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Chart of S&P 500 with 1-Week Rate of Change (Weekly)

S&P 500 and Dollar Forecast Leads Global Markets with Elections Expectations

Chart Created on Tradingview Platform

Taking stock of periods around previous US elections, there is a tendency for risk assets to ease back in what seems a natural deleveraging effort. In the weeks leading into the 2016, 2012 and 2008 Presidential elections, there has been a short-term retreat that was in turn followed by a restrained but buy persistent bid. Of course, this period has been defined by one of the longest and most pervasive bull trends on modern record; so this perhaps has as much to do with the undercurrent of sentiment as it does with the actual outcome in the elections. The question worth carrying forward is whether that speculative opportunism or complacent bid is as appropriate now as it was in previous years. With a pandemic, extreme economic volatility, faltering stimulus, trade wars and so many other issues threatening the fundamental backdrop; markets may be simply waiting for a reason to throw in the towel.

How could US elections impact the markets? Click here to see our aggregate report on themarket reaction to election.

Chart of S&P 500 with 1-Week Rate of Change (Weekly)

S&P 500 and Dollar Forecast Leads Global Markets with Elections Expectations

Chart Created on Tradingview Platform

The Presidential Election

This Tuesday’s Presidential election seems to have the attention of market participants the world over. Implied (expected) volatility readings may not be at panic levels but they are significantly elevated to the point of being a more persistent thrum against conviction. The VIX has held above the 20 mark for 175 trading days – a ready transition from coronavirus fears into political uncertainty. Looking at the polls heading into the weekend, former Vice President Joe Biden leads incumbent President Donald Trump by 7.8 percentage points according to the average measure from Real Clear Politics. Of course, the election is an electoral college so there is very much room for uncertainty on the outcome.

Chart of Biden and Trump Election Polls Average

S&P 500 and Dollar Forecast Leads Global Markets with Elections Expectations

Char from Real Clear Politics

With the pullback in the Dow, S&P 500 and so many other risk-leaning benchmarks this past session, I took a poll at the height of the swoon whether traders believed we were entering an earnest bear trend, whether it was another pullback that presented opportunities for patient bulls or it was all dependent on the November 3rd election results. The split was remarkably even. It is remarkable because the dip buying mentality has been far stronger on average over previous years. Yet, the recognition of the upcoming election’s sway over markets should not be overlooked.

Twitter Poll for Whether Risk Trends are Bearish

S&P 500 and Dollar Forecast Leads Global Markets with Elections Expectations

Poll from Twitter.com, @JohnKicklighter

Expected Election and Market Outcomes

Overall, I believe there are two distinct, market-moving outcomes to consider for the forthcoming election: whether the elections render a clear result or a contested election pushing uncertainty and volatility to new heights. If there is a legal scrap over the results with the possibility of a flip from initial numbers, the longer the uncertainty, the greater the sense of uncertainty will be with capital looking to avoid the fallout. Interestingly, I asked in a poll what traders thought the outcome of the election and the subsequent market (S&P 500) response would be. The view on winner was close to 50/50, but what is remarkable to me is that the bullish scenarios for both candidates totaled approximately 76 percent of the expected outcome. I would agree that the President has limited sway over the actual performance of the market, but the economic and financial backdrop after the election is certainly far from encouraging.

Twitter Poll for Whether Risk Trends are Bearish

S&P 500 and Dollar Forecast Leads Global Markets with Elections Expectations

Poll from Twitter.com, @JohnKicklighter

Meanwhile, the assessment for the US Dollar carries very similar circumstance. Here too, the question of a contested outcome should be considered a principal consideration. Again, a 50/50 break in expected winner across the scenarios is less interesting than the more than 62 percent anticipation for a Dollar advance with a decisive outcome. While I’m dubious of the equity/risk assumptions, a Greenback lift may be more reasonable an assessment given that the there is little political consideration for parties to hold out on a follow up to the CARES Act stimulus. While the program may be larger or smaller depending on what the composition of the Legislative and Executive branches may be, it is still likely to result in fresh support.

Twitter Poll for Whether Risk Trends are Bearish

S&P 500 and Dollar Forecast Leads Global Markets with Elections Expectations

Poll from Twitter.com, @DailyFX

What Roll Will the Dollar Play

The question over the market’s ultimate bearing this week will hold considerable weight for the performance of most assets. However, the Dollar’s alignment will hold particular interest for me. Should a contentious election outcome complicate the immediate economic and financial futures, the Greenback’s performance will prove particularly informative. The currency would be at the center of the uncertainty in such a scenario, but its safe haven status would flash an alluring signal to global investors regardless. The correlation between the DXY Dollar Index and VIX volatility index in such a scenario would be particularly important.

Chart of DXY Dollar Index Overlaid with VIX Volatility Index (Daily)

S&P 500 and Dollar Forecast Leads Global Markets with Elections Expectations

Chart Created on Tradingview Platform

How the US currency orients is an important statement on the overall picture of the global markets. That said, I would argue that the perception of relative value is perhaps even more important moving forward than the general view of ‘risk’. Now, should market-wide sentiment commit to a systemic course, traders should take clear note. There is nothing more capable of developing market-wide swells or slumps for the financial system than the perception of investor confidence. That said, in the absence of clear commitment to a statement on ‘risk on’ or ‘risk off’ can still afford a relative progression for the likes of EURUSD. The benchmark cross eased with the Dollar’s own firming this week. Yet, it would be difficult to miss the larger technical implications facing the pair if you didn’t look at the weekly or monthly charts. Would the market reverse such hard-wone climb? It is more than possible.

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Chart of EURUSD with Net Speculative Futures Positioning (Weekly)

S&P 500 and Dollar Forecast Leads Global Markets with Elections Expectations

Chart Created on Tradingview Platform

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