There are many themes that run through the current bull market, but perhaps the most important theme for investors is this: any news that can be interpreted as bullish – no matter how contorted the logic – will indeed become a bullish catalyst.
The Georgia runoffs are just the latest piece of major news that fits this theme. A little recent history is required for perspective. Markets gyrated in October as they digested the prospects for a “Blue Wave”, in which Democrats would control both houses of Congress and the White House. That scenario was originally interpreted as a bullish when markets fixated on the idea that it could result in greater fiscal stimulus. Then the interpretation turned bearish when markets focused on the idea that higher taxes could result. We can see that month’s peak on October 12th and trough on October 30th, the Friday before Election Day.
Source: Interactive Brokers Trader Workstation
We all know what happened next. Markets decided that they loved the idea of a split Congress. There is considerable historical precedent for that love. Equities have tended to perform well during periods when one party is not in control of both houses of Congress and the Presidency. (Never mind that it is unusual to have lasting one-party rule in the US, and that markets tend to go up over time, so it is kind of inevitable. But I digress.). Major indices zoomed after Election Day and have not looked back since.
Yesterday we wrote, in reference to the market’s about-face in November: “… it is more likely that markets simply wanted to rally and found a convenient narrative to justify higher prices. If that was indeed the case, we have to question how much of the rise would be at risk if that narrative is upended. A 50-50 split in the Senate (with the Vice President breaking ties) would still make it difficult to enact the sort of sweeping legislation that markets fear most.” That is indeed the Goldilocks interpretation that we see in place today. Investors are enamored with both the prospect for future stimulus AND the obstacles that a 50/50 Senate split would place before any significantly unfriendly tax legislation. Voila! Another boon for investors. So what if the likely runoff result upsets the narrative that drove the market higher for the past 2 months? Heads I win, tails I win.
We also discussed that on Monday, options markets indeed did begin to price in greater risk arising from the runoff. That turned out to be quite appropriate. If you find that statement curious, it is crucial to understand risk from an options professional’s viewpoint. I spent decades as an options trader. We strove to be largely delta-neutral (meaning we minimized our net exposure to individual shares and the market as a whole) and profit from volatility. We made money if we were long volatility and the market moved more than our assumptions, and vice versa. When you remember that volatility counts in both directions – not just in down moves – we see that today was indeed a volatile day. So far, the S&P 500 Index (SPX) has traded in a 60-point range, or about 1.5%. That equates to an annualized volatility of about 24, which was in line with the implied volatilities of near-term SPX Index options.
I realize that my definition of risk is not necessarily the same as those of long-only investors, and that many of you indeed fit that description. For that I apologize, because you need to be much more concerned with risk of loss than of gain. You invested in stocks because they tend to go up, the more the merrier. An upside move is not a risk to you, it’s a benefit. But since many of you also employ options in your investing strategies – either as a writer for income or for outright speculation – it is crucial to understand risk in a multi-dimensional manner, not simply as the potential for loss. In the meantime, until the message of the market tells us otherwise, any news that can have a bullish interpretation will get one. It’s too bad that markets are fickle, because that message can change quickly and without warning. But it’s fun for many investors while it lasts.
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