October 14, 2020

Political Sentiment

There’s one left.

This week brings the last pre-election monthly options-expirations cycle. It’s the final time to take or manage risk with options that expire after votes are cast. It might be instructive about trading bets. Options expire Thu-Fri this week, and through Oct 21.

In Oct 2016, Market Structure Sentiment peaked the 3rd at 6.6/10.0.  The market was over 49% short. Sentiment leaked down to 4.0 (you longtime readers know the market trades between 4.0 on the low end and 6.0 on the high end most times, and coloring outside those lines often signals temporary bottoms and tops) by Oct 21.

But demand was weak. Sentiment is a supply/demand gauge. It must stay above 5.0 to rise, more demand than supply (above 5.0, stocks rise, and below 5.0, they fall, a mathematically consistent truth, subject to periodic variance). In 2016, Halloween was the top, a tepid 5.0, a bare mean reversion.

It’s the market equivalent of trying to jump the bridge in a Yugo (a humorous blast from the past for all you too young to know it).

Stocks began Nov 2016 with a feeble wheeze and rolled over into the election.  We thought the bull market might end.  Stocks were trading lower than in June 2015.  Sentiment double-dipped down to 3.6 Nov 9, the day after the election.

And then, boom!  Sentiment hit 7.7 Nov 25, the best read since July 2016 after Brexit shocked stocks and juiced them like a pro-cycling blood-doper. Short volume dropped below 45%.

Brexit is an apt comparative too, an unexpected outcome. Market Structure Sentiment bottomed June 23, 2016, the date of the vote, at 4.2 (it rose to 8.2 by July 20).

So, what’s it mean?  Market bottoms signal gains ahead.  Did investors secretly think Brexit would happen and Trump would win?  Both events brought party times for equities, undeniably.

Or is it the opposite?  Investors were so dour about Brexit and the 2016 election – purely in terms of market outcomes – that the nadir for quantitative reads on supply and demand fell exactly in step with both events.

I don’t know.

But I’d argue from vast seas of data spanning 15 years that enthusiasm leaks.  It’s like an ambush (admittedly a dubious analogy but follow me here) where those lying in wait are so gleeful about holding what they call in poker the nuts – the winning hand – that somebody amped on adrenaline accidentally squeezes off a round and spoils the surprise.

Frankly we see it all the time in deal situations and Activism.  Somebody just can’t help herself and takes out a long swap or something. It’s not illegal to bet on information others don’t have.  It’s only illegal to sell it.  The point is, we often catch clues about ebullience in the unmistakable humanity of front-running.

With that yardstick, the absence of any giddy bursts of early gunfire, you’d conclude investors thought Brexit would catch a toe and plunge into the pond. And a Clinton administration would land with a thud on The Street.

So.

What do the data say now?  We’ve written repeatedly – especially in our private Market Desk notes (if you want those, subscribe to our analytics and become part of the Market Structure club) – that there’s another Big One coming.  A sprawling splat for stocks. The data say so.

There was one coming in Oct 2016 too, that the apparent benighted election of Donald Trump cast in glorious light – extending the bull market all the way to Covid.

And right now, the signals say the Big One most don’t see coming is after the election. On that loose read, you could say the market is betting on a Biden regime (because it would arguably be less business-friendly than the current one, regardless of one’s sociological persuasions around candidacy).

However, shorting is very low – below 43% marketwide.  The stumbling, bumbling, weaving pattern predicting a splat for stocks into Tue Nov 8, 2016 already happened.  Between Sep 9-Oct 1, 2020, Market Structure Sentiment peaked, then fell near 4.0, crawled back to 4.9, rolled back down the hill, Sisyphean, to 3.4 about Oct 1.

And then delivered the best gains for stocks since the week ended June 5, 2020.

Right now, it’s 7.3, steamy, nearing a top.  That kind of verve tends not to precede demolition to shareholder value. I’d bet stocks will decline to a bottom by roughly Oct 22 and rebound into Election Day.

I’m not saying that’ll happen.  And humans were wrong about Brexit, wrong about 2016.  And they could as well be wrong again here.  But that data would suggest an expectation the election won’t be bad news for stocks.

That might be bad news in other ways. And the data haven’t come in yet. We’re speculating. And we’ll keep you posted in Market Desk notes, clients (send us a note and become a client and you too can read the quantitative tea leaves!).

Now, back to the political-ad beatings.

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