Goldman Sachs Traders Assess Election Market Strategies and Volatility

Goldman Sachs Traders Assess Election Market Strategies and Volatility 

With the upcoming election, the Goldman Sachs trading desk has observed that clients are beginning to position themselves for various potential outcomes, particularly leveraging the optionality that arises from the binary nature of the election result. Recently, it has become increasingly evident that Wall Street appears to be heavily favoring Donald Trump's candidacy, with many aligning their strategies accordingly.

At this point, the implied volatility for the U.S. presidential election is sitting at a mere 2%. According to Brian Garrett from Goldman Sachs, this is the lowest level ever recorded since the firm began tracking what is known as excess variance. Garrett suggests that this number might be underestimating the level of uncertainty or risk that should be expected, implying that the market may be pricing in too little volatility given the potential for a significant move after election results are finalized.

Goldman Sachs trader Louis Miller adds to this analysis, pointing out that with only two weeks left until the election, there is a notable shift in client attention towards the possible outcomes. The market has been moving strongly in favor of a Republican victory, and this is clearly reflected in the performance of the Republican Policy Outperform vs. Underperform pair (tracked by the GSP24REP Index). Currently, this index is about 2% away from its five-month high and 3.3% below where one would expect it to be if the odds were split at 50/50.

If we overlay the PredictIt odds, which represent betting markets, one could argue that the broader market is now priced for a scenario where the odds of Trump winning are around 55/45 or even 60/40. However, it is crucial to recognize that this race remains tight, and the outcome could still swing in either direction.

Even with the strong Republican tilt in recent trading activity, Miller notes that there has been a slight cooling off, as evidenced by the Republican basket pair remaining flat while the long leg of the trade has declined more than the broader market. This cooling off has prompted some clients to start asking more nuanced questions, such as: "Is a Republican sweep really beneficial for the market?"; "Are there assets or strategies that could perform well regardless of who wins?"; and "What's the best way to position oneself if the race tightens in the final stretch?"

Before diving into these questions, Goldman Sachs has provided a cheat sheet for how different election outcomes could impact various asset classes. In addressing whether a Republican sweep would be good for the market, the consensus seems to be that markets may indeed rise on the news of a Republican victory, with interest rates likely to sell off. This would be due to expectations that both nominal and real GDP growth would be above trend, which isn't necessarily a negative for stocks over the long term.

That being said, inflation remains a key concern, though for now, true inflation that impacts consumers in a meaningful way (outside of wages and housing) has yet to become a significant issue. Rate changes, however, matter a great deal. A two-standard-deviation move in rates, which equates to roughly a 60-basis-point change, has historically been negative for equities. Over the past month, we've already seen a 40-basis-point move, and Anshul Sehgal, who oversees U.S. interest rate products at Goldman Sachs, notes that the market is pricing in an additional 20-basis-point breakeven move over the election period.

From a thematic standpoint, the Republican Policy pair has traded in a pro-cyclical fashion, meaning it has benefited from broader economic trends. However, we could see a shift towards higher-quality assets, with less emphasis on smaller companies like those in the Russell 2000 or regional banks, and more focus on high-quality cyclicals or a tailored Republican-focused basket. It's worth noting that the Wolfe Interest Rate Sensitive pair (tracked by the GSPU10YR Index) has been moving in line with rates, while higher-quality baskets have underperformed, suggesting the market is expecting a similar outcome to 2016.

When considering assets that could perform well under either candidate, Goldman Sachs points to small business exposure, specifically the GSXUSMBB Index, which tracks small businesses compared to the broader market. Simply lifting the overhang of uncertainty from the election should be a positive for small businesses. Both candidates, whether it's Trump or Harris, have policies that could benefit small businesses in different ways. For instance, Kamala Harris has floated the idea of a $50,000 small business tax credit for new businesses, though this would depend heavily on Congressional margins. On the other hand, Trump's deregulatory agenda and potentially lower corporate taxes could also lift sentiment, assuming he is able to confirm his cabinet picks and navigate Congressional dynamics.

Short-term interest rates falling could be a boon for small business sentiment, which has been somewhat depressed, and the current valuation of this basket reflects the market's pessimism.

In response to the question about how to play the odds of the race tightening in the coming week, Goldman has developed a renewables-focused basket called GSCBDMRN. This basket is particularly geared towards tracking the odds of Kamala Harris winning, as reflected in various prediction markets.

Lastly, while these tactical trades and strategies are based on election outcomes, Paul Tudor Jones offers a more long-term, strategic view. He argues that the most inevitable trade, regardless of who wins, is the increasing likelihood of inflation. Drawing on Japan's experience and the current fiscal crisis facing much of the West, as highlighted by recent warnings from the IMF, Tudor Jones suggests that inflating out of the crisis seems to be the most likely path forward.

In terms of how he's positioning himself, Tudor Jones is clear: "I think all roads lead to inflation. I'm long gold, I'm long Bitcoin, and I think commodities are ridiculously under-owned, so I'm long commodities. I think many young people hedge against inflation through the Nasdaq, which has worked well. As for bonds, I would own zero fixed income.