How to Trade the Political Headlines

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Some headlines connected the disarray in the Iowa democratic caucus to market gains this week. Is that fair, and if so, how might investors play such political events?

 

The battle for the democratic presidential nomination took a dramatic turn this week.

The results of the Iowa caucus were thrown into disarray late Monday after the Iowa Democratic Party delayed releasing results.

The final count ran into trouble Monday night after what Iowa Democrats found what they called “inconsistencies.” As to the source of the problem, officials are blaming “coding issues.”

As I write Thursday morning, here are the latest results:

 

Source: The Associated Press

 

Now, there was an interesting investment angle on this …

On Tuesday, markets soared. And some headlines attributed these gains to the uncertainty in Iowa.

Why?

Well, the idea is that any missteps with democrats increases the likelihood of a Trump re-election … which, apparently, some believe would be better for the stock market.

Here’s an example of one such headline:

 

 

Is this a fair conclusion?

Whether yes or no, it prompts another question … as we approach the presidential election, should political events change how you invest?

With this in mind, I turned to our resident trading expert, John Jagerson. John is one of the minds behind Strategic Trader.

As a quant, John studies market history and patterns to give him a trading edge. His extensive technical knowledge is, in part, why Strategic Trader is one of the most successful trading services in the industry.

Yesterday, I grabbed John to get his thoughts on Iowa, short-term trades based on politics, and the 2020 election. Specifically, I wanted to know if there was a way for investors like you and me to capitalize on political events like what we saw in Iowa this week.


***Political headlines — ignore them or trade them?

 

Jeff: Let’s start broad. Should investors brush off any politically related news stories that might move the markets as we approach November?

John: My answer to that is “yes” for any period longer than a few days, but “no” for short-term moves of 24-36 hours.

Jeff: Actually, before I follow up on that, let me ask a question that probably should have preceded this. How do we even know that something that creates political headlines is the cause of a market move? I mean, investors could be mis-attributing market volatility, right?

John: Absolutely. Sometimes the market moves a lot in a day without an obvious catalyst, which is when investors need to be careful about taking the headlines too seriously.

It is common for the financial press to take whatever major news happens on a given day and report that as the “cause” of a bullish or bearish move.

The trap here is the “post hoc ergo propter hoc” fallacy — which means “after this” or “therefore because of this.” This happens frequently on Thursdays when the market moves but the only big news is the jobless claims numbers. Historically, these numbers have no correlation with the market, but occasionally a bad jobless claims report happens on a bad day and the press prints that as a causal relationship with the market’s performance despite the fact there is no historical data to back that up.

 

NOTE: Below is an example of how the headlines try to attribute a market move to just a single variable. This comes from earlier this week.

 

 

Jeff: On that note, what do you think about some of this week’s headlines trying to connect the Iowa disarray to market gains? Basically, the idea that markets rallied on the belief that the Iowa confusion increases Trump’s chances of reelection?

John: There are at least two embedded premises in a headline like what you’re referencing. First, investors would be encouraged by Trump serving another term as president. Second, the disorganized Democratic party of Iowa is representative of the organization the entire party — and eventual nominee — will run.

Frankly, I have never had that much confidence in politicians or political parties, so I feel like the second premise is at least plausible. However, the first premise deserves a little more analysis. Would a Trump-second-term be better for the market than a new democratic president?

In my experience, I have found that investors commonly assume that markets do better under Republicans than Democrats. The S&P 500 rallied more than 38% in the first 3 months after Trump was elected. As of this week, the S&P 500 is up nearly 60% overall since the day after the election in 2016, which in fact represents excellent annual returns.

As far as first term results go, Trump’s has been pretty good. However, since the 1950’s Trump’s first term performance is in 4th place (so far) behind Eisenhower, Clinton, and Obama which seems to indicate an even split between performance and political party.

The worst one-termer was Carter, coming in at -9%, and the worst two-termer was George W. Bush at -26%, which again suggests the president’s party may not matter as much as the press would have us believe.

NOTE: John provided the chart below showing market gains under various presidents.

 

Source: MacroTrends.net

 

Jeff: But is it really fair to attribute market gains to a president?

John: I think such an attribution is neither accurate nor fair to the actual Americans doing the work to make the economy grow.

Jeff: Okay, so if economic growth on the shoulders of Americans is the real mover behind the stock market, then it would seem that a short-term market overreaction to a political headline could be a trading opportunity, as the market shrugs it off after a day or two.

John: Correct. Because short-term fluctuations in the market aren’t driven by what “is” but by what investors think the future “will be”, bad assumptions can still affect the market in the short term. Those future estimates are full of biases and plenty of irrationality, such as Trump being better for the market.

So, let’s assume a new poll is released that shows Trump losing to the likely Democratic nominee. If the market drops an unusual amount, that is a short-term over-reaction that should be viewed as a buying signal.

Similarly, while a rally following bad news for Democrats might pop prices, investors should hesitate before buying with both hands as a reversion back to the mean is likely.

Jeff: But wait — if connecting a headline to a market move isn’t always certain, how do we make that call?

John: That is a good question. Sometimes we have to just make our best, most reasonable, guess. For example, I can’t prove that Tuesday’s rally was the news from Iowa, but it seems like a reasonable correlation.

What we need to do to raise our confidence is to see what happens the next time we have a similar news event. If the market responds similarly assuming some kind of snafu in New Hampshire or Virginia, then we can be more confident about the pattern.

If there is no recurrence, then we are left kind of guessing. The point is to make sure we are properly weighing our confidence before making an investment decision. In this case, I am less confident so I would be very conservative about the amount of risk that I add.

Jeff: Okay, with that disclaimer, what’s the best way to play political moves? Are there certain sectors or stocks that are especially sensitive to politics?

John: I think banks, tech, energy, and basic materials would do well after a whipsaw.

Jeff: Any particular names to look at?

John: I would be in favor of the large money-center banks like BAC, MS, JPM, and C which will likely perform better under a republican presidency because of fewer regulations. I think this is a sector where assumptions about democrats vs. republicans would make sense.

The opposite of this would be to expect healthcare stocks, besides pharma, to do very well if democrats look better. Love it or hate it, the ACA was a huge profit windfall for hospitals and insurance companies so I would expect bad polls for Trump to be good for them.

Jeff: And the average hold period for a headline-trade would be just a day or two?

John: Yes. Trading the whipsaw is probably a very short-term position of a day or two. Plus, given the nature of these moves in addition to the timeframe, this is an ideal situation for options.

Jeff: Wrapping up, if we jump ahead to November, which sectors do you like for who makes it into office?

John: If a dem starts looking good, I would lean towards retail and healthcare. If Trumps re-election looks solid, I would lead towards the financial sector.

Jeff: Thanks, John.

In Strategic Trader, John and Wade take advantage of headline events with their options positions, but only if strong fundamentals underpin the trade. This focus on quality is, in part, why Strategic Trader is one of the most successful trading services in the business.

Most seasoned traders will tell you you’re lucky to win four out of 10 trades. Meanwhile, John and Wade are averaging roughly nine out of 10 profitable trades, for an average annualized yield of over 21% on capital — in other words, zero margin. That’s a fantastic track record.

To learn more about the Strategic Trader strategy, click here.

Have a good evening,

Jeff Remsburg


Article printed from InvestorPlace Media, https://investorplace.com/2020/02/how-to-trade-the-political-headlines/.

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