The Unprecedented Trading Phenomenon
The Anomaly in Market Sentiment
As the US presidential election countdown begins, perhaps Buffett’s famous saying rings true again: be greedy when others are fearful. Recently, Goldman Sachs traders have witnessed a rare phenomenon in their careers. When the “fear index”, VIX, which measures the volatility of US stocks, is at a high level, clients are surprisingly bullish on US stocks. In response to questions about capital flows towards the end of the year and the trades made by clients across the entire Goldman Sachs franchise, Brian Garrett, managing director of cross – asset derivatives sales at Goldman Sachs, said, “I can’t recall a time when VIX exceeded 22 and the client base was unanimously bullish… The economic and growth data are strong, and people think inflation is largely under control… The election is a wall of worry, but a peaceful transfer of power plus a volatility readjustment could trigger another wave of risk – taking trades by the end of 2024.” Garrett said that a common practice he heard in conversations with investors is, “We go long and deploy more capital after the election.” If you’re in this camp, you’re not alone. The implied moves of the S&P 500 are 2%, the Nasdaq 100 is 2.5%, and the Russell 2000 is 3.6%. These are reasonable hurdles for option buyers to overcome, so most hedging is in a delta form.
Trading Strategies and Outlook
Garrett believes that the most interesting trades after the election will be in individual stocks/themes. Different election results will have a significant impact on industries and sectors, but could also lead to relatively flat diversified index trading. Garrett said he likes to trade against the steep VIX curve, such as using the proceeds from VIX December put options to buy VIX November put options. He also likes to take advantage of the upside in gold (Goldman Sachs research is still very bullish on gold) and look for individual stocks that could benefit from deregulation or mergers and acquisitions under the next administration. Garrett doesn’t think small – cap stocks will repeat their outstanding performance after the 2016 election. “In fact, I don’t think the 2016 playbook ‘worked’ as some people think.”
Hedge Funds and Market Risks
John Flood, head of Americas Equity Execution Services at Goldman Sachs, found that hedge funds continue to trade “Republican policy winners” at an extremely high rate. Flood believes that if Democratic candidate Harris is elected, it will lead to a sharp unwinding of this recently increased risk exposure and put heavy pressure on the broader indices, such as the S&P 500 dropping rapidly by 5%. Flood pointed out that mutual funds, which account for 22% of total assets under management, ended their most recent fiscal year in October. Earlier in October, Goldman Sachs saw significant tax – related selling in several members of the tax – loss – selling basket (GSCBMF24 INDEX). It’s worth paying attention to these underlying assets as there are some interesting buying opportunities.
Investor Sentiment and Post – election Outlook
Jon Shugar, head of equity cross – asset sales at Goldman Sachs, said that investors are currently trying to reduce their gross and net exposure before the election. For the post – election market, investors are still expressing confidence in the upside of gold (both direct and related mining) and the potential benefits of financial deregulation. Shugar said that most of the investors he talked to hope to increase their risk in US stocks after the election. Regarding the election results, Shugar still thinks that the foreign exchange trading is mispriced. Either a Harris victory would lead to a weaker dollar, or a Trump victory would cause the euro – dollar to fall – both are possible scenarios. The biggest question might be the ultimate direction of long – term interest rates. Chris Spahr, director of synthetic sales trading at Goldman Sachs, said that about a month ago, clients’ views were “risk – reduction” and “wait – and – see” until the election results were out. Now the situation has completely changed – clients have made a decision and have started to be on the offensive in Trump – related trades (shorting the tariff basket, going long on the Republican policy theme basket, and going long on cryptocurrency ETFs). As Trump’s advantage grows and the Senate is a tough battle for the Democrats – the red wave of the Republicans taking over Congress looks increasingly likely. Lee Coppersmith, director of derivatives sales at Goldman Sachs, said that previously, clients focused on adjusting their portfolios in response to a Republican – dominated election result, and now the capital flow is changing in the opposite direction. Goldman Sachs has seen an increase in demand for industries more balanced towards Democratic policies, such as solar/renewable energy and bond substitutes. On the other hand, driven by deregulation and M&A benefits, the Goldman Sachs trading desk still sees great value in certain financial areas.
