The Volatility shock till 8th November

The Volatility shock till 8^th November

History will be rewritten and the World Markets would get direction on 8^th November when US elections will be held ...Till then be prepared for a lot of Volatility in markets all over the world.

We had our October surprise, and it should not have been surprising. We should also be prepared for a November surprise, and treat rising volatility in the week before the US election as a racing certainty.

What is beyond doubt is that the markets are scared of a victory for Donald Trump. Volatility remains low, but the Vix index has risen sharply twice since June’s Brexit vote on September 12, after Hillary Clinton was taken ill and admitted having pneumonia, and this week after a tracking poll showed Mr Trump in the lead.

To deal with this we must break the issue into component parts. First, who is going to win, with what probability? Second, is that probability priced in? And third, what effects would each outcome have on markets?

Note that the outcome is not binary. A Clinton victory may be accompanied by control of the House, while a Trump victory could be accompanied by Republican loss of the Senate. There are also possibilities that Mr Trump does not accept a defeat, or of a constitutional crisis following a tie in the electoral college extreme and unlikely events that would spell disaster for global markets.

So, who is going to win? Prediction markets capture prevailing opinion and put a number on it. They may not be right, but they express the prevailing wisdom. Growing publicity for their remarkable success in calling elections.

There are different markets, but all show remarkable assuredness that Mrs Clinton will prevail. PredictWise, which aggregates prediction markets, has never shown the Democrat’s chances as lower than 72 per cent and puts them at 84 per cent. But this conceals a wide variation. PredictIt shows Mr Trump’s chances doubling in the past week to 37 per cent. The Iowa Electronic Markets, the longest continuously operative prediction market, which is less liquid than some, shows Mrs Clinton’s chances at only 57 per cent.

Latest polls show her advantage in the RealClearPolitics average falling to only 1.7 percentage points, from 7.1 percentage points two weeks ago, and behind in Florida, Ohio, Nevada and North Carolina. That makes the prediction market odds on a Trump win sound generous.

It therefore looks as though the probability of a Trump victory remains under-priced on markets, and could easily swing wildly in the next few days. It is a property of betting on a binary out come as the event approaches, there is less time for a bet to pay off. That means volatility will rise. If anyone betting on Clinton has doubts, they have only a few days to sell, and doing so will depress the price further. Big swings in prediction markets in the last few days of a campaign are the norm.

The impact? Markets have not moved much so far in part because it is unclear what a win for Mr Trump would mean. His policies are unclear. This intensifies the chance of risk premia rising. But US Treasuries are havens. People buy them even on news that is ostensibly bad for the credit of the US. Treasury prices rose in 2011 after Standard & Poor’s downgraded their credit rating. So victory for a man who says he might deliberately default on Treasury debt might lead people to buy more US government paper.

A further issue is that Mr Trump might try a big fiscal stimulus, with infrastructure spending and tax cuts. This would mimic Ronald Reagan, and imply a strong dollar and higher bond yields which might be good for the US economy but terrible for international asset prices.

So, the next week is perilous. A little gold, or some Vix futures, might be a good idea, treated as an insurance premium. Volatility could easily rise far higher from here. And within reason, it is good to hold cash. It gives optionality. Cash can be rapidly redeployed, and that is appealing.

Finally, Trump futures offer value. Anyone who bought one for 9 cents on the dollar on the Iowa market two weeks ago has made a 365 per cent profit, and should consider selling. But some exchanges still put his chances below 20 per cent.

Trump futures have made a 365% profit in two weeks consider selling and taking home the profit.

The VIX in the Indian market would rise to a great extent as Trump victory could impact many sectors like IT and IT related, Pharma etc ... which have a great exposure to the US market in a big way and would lead to a correction in the market with a period of uncertainty till the time there is complete clarity on way the Trump policies would shape out or were they just election promises. In case of a Clinton victory, there would be a mild positive for the markets for a few days and then it would be treated as a non-event as no major change in policy is seen that would make any material impact on any sector as such. Hence there would be lot of volatility in the markets till a real clear picture emerges.

_ Farzan Ghadially