How to trade the US election

While we were wearily sipping our black coffee Monday morning, a WhatsApp landed on our personal phone with the following question:

Now just to be clear, we’re not financial advisers nor investors (the sum of our total invested savings amounts to a pithy pension pot in target date funds), so our reply was naturally “that’s a mug’s game”.

Still, it’s a good question right? And with election day tomorrow, we thought it was worth exploring a bit further via the medium of the sellside note. So here’s the best of it, including some analyst ramblings from a few weeks back.

First, the bank formerly known as the vampire squid stepped up to the plate today with a note on, you guessed it, volatility.

Here’s Goldman on a rather large spread between realised volatility and implied volatility going into election day:

With vol risk premium extreme, safely positioning for lower volatility is timely. The VIX’s 80% and 15-point premiums to exponentially weighted realized vol have been rare historically, and one way these can return to normal would be for a clear election result to drive implied volatility much lower. However, (1) close races in key states that will be accepting mail-in ballots that arrive later than Election Day, reducing the odds that results will be known this week, and (2) the high volatility environment driven by COVID-19 both threaten to thwart rapid post-election vol normalization. In the high-volatility election periods of 2000 and 2008, the VIX exceeded its pre-election peak later in November.

And the relevant chart:

The trade here depends on not on your view of who might win, but whether the other side will accept the result. Given the current state of the polls and the noise the Trump campaign has made about the legitimacy of mail-in ballots, it seems a reversion back to normal levels of volatility may take some time.

Moving on, there’s a note from Stifel which, handily, breaks down the results into a “blue sweep”, a “Biden stalemate” and “Trump win”, and then takes a look at which companies might be effected by each outcome. It’s a 78-page note so we’re not going to publish much of it here, but it does contain some interesting -- and surprising -- views.

First is that energy drink vendor Monster Beverage’s revenues could boom in event of a Biden win. Why? Because of infrastructure spending! Duh:

A large infrastructure plan uniquely favors Monster, likely providing upside to top-line numbers, given positive correlation with construction spending. Infrastructure spend also likely supports U.S. miles driven, a long-term driver of c-store energy drink purchases

We’re not sure whether this is a prime example of the axiom “correlation doesn’t equal causation”, or if Monster sales of caffeinated sugar water do move somewhat in-sync with shovel ready spending. Still, there could be good news on Wednesday for holders of a stock that, over the past decade, has returned 815 per cent -- more than Facebook, and just 10 percentage points below Microsoft.

Elsewhere in the note, Stifel takes a look at the cannabis industry, as a Dem sweep could bring widespread legalisation back into play. It’s more than two years now since the infamous weed stock bubble, when names like Aurora Cannabis (down 95 per cent in the past two years), Tilray (down 94 per cent) and Canopy Growth (down 47 per cent) came to markets with high dreams. So it could be time to start digging through the rubble if Sleepy Joe takes the White House.

Here’s Stifel’s view of how that might play out:

A Blue Wave would suggest a unified federal government more amenable to cannabis reform. We believe a Blue Wave is likely to include numerous headlines promoting the prospect of wholesale federal change, including the descheduling of cannabis (as included in the MORE Act, which was scheduled for a vote in the U.S. House of Representatives) by removing cannabis from the purview of the Controlled Substances Act. Given the heavy retail exposure and likely promotion of the potential for federal change, we believe a Blue Wave would bring broad undifferentiated favor to cannabis equities.

Even with a unified Democratic government, we believe the current environment is likely to endure. In an interview with popular cannabis media outlets, Senate Majority Leader Chuck Schumer (D-NY) suggested marijuana legalization will be a priority, with his proposal seeking full descheduling. We do not believe federal cannabis reform is well understood by or important to the average voter, and, therefore, it is not a priority for lawmakers, suggesting limited risk of making this promise to this niche constituency. Even if the legislation is prioritized, we believe lawmakers will consider constituencies that adamantly oppose cannabis as well as entrenched constituencies supported by the current U.S. state licensed cannabis industry, which we estimate will reach $15.5 billion in sales in 2020. These constituencies would be upended by full legalization through the descheduling of marijuana, with large consumer companies standing to benefit, given their ability to leverage cash generating businesses to deploy capital behind the cannabis category. However, there may be legislative or executive action resulting in decriminalization of personal use, with the potential for accommodations/firmer assurances of non-intervention to U.S. operators: STATES Act, SAFE Act, unified guidance from the Justice Department akin to the Cole memorandum, updated FINCEN guidance, expansion of Rohrabacher-Farr for adult use states and operators.

Decriminalization of personal use at the federal level would be a tailwind for the category overall by enhancing the growing mainstream appeal of cannabis, which has been a consistent driver of the category’s growth. Through firmer assurances of non-intervention, we believe the most likely significant change will be a reduced overall cost of capital for U.S. operators due to restrictions around banking access being eased. With firmer assurances of non-intervention, financial institutions and exchanges could exhibit enhanced risk tolerance, suggesting the potential for well-positioned U.S. operators to list on one of the two largest U.S. exchanges. To be clear, however, in the scenario we outline, we believe cannabis will remain federally illegal, with assurances of non-intervention not offsetting the risk of future prosecution.

Our final port of call is Jefferies, who released a note just over a week ago on how to play the election.

While we’re not going to dive into all the detail, we thought these two charts would be worth sharing with any readers who’d like to bet on the US election via the medium of European companies. No idea why you’d want to do that, but you know, you do you.

Here’s the investment bank’s top Biden picks (right click and open in a new tab to make massive):

And, conversely, the Trump trades:

Still, even if we had replied to our mate after reading these notes, the answer would still be the same: betting on an election via stocks is a mug’s game.