After a decade of unimaginable prosperity that has followed one of the worst financial crises in history, the market’s mood is changing. Many of the wealthiest investors are starting to grow wary of making money with such little effort.
It’s no longer enough that interest rates are low, making it relatively inexpensive to profit in the stock and options markets.
With stocks still dancing around record levels, the perception that sentiment is changing among the market’s elite could upset the bullish balance.
Rather than focusing on the usual concerns—economic data; the on-again, off-again trade war between the U.S. and China; the United Kingdom’s tortured Brexit process—these investors are increasingly focusing on the train wreck of U.S. politics.
High-net worth investors and their advisors don’t typically ask that their portfolios be protected with hedges. Now they are doing just that. They are also closely watching the Democratic campaigns and primaries and planning to use the election results to evaluate the health of the stock market and their own portfolios. Normally, such investors react to events, or get herded into some wonderful financial product that was dreamed up by suave bankers or structured-finance wizards with European accents.
But these investors are increasingly focusing on mundane portfolio hedges with S&P 500 index options, or calls on the Cboe Volatility Index, or VIX, that could increase in value around the first few Democratic primaries in February. Some of them say that they are hedging stocks or creating tactical wagers that the stock market will decline if Sens. Elizabeth Warren (D., Mass.) or Bernie Sanders (I., Vt.) emerge victorious.
The concerns might seem a bit dramatic, but they likely reflect the trials and tribulations of President Donald Trump, who faces impeachment proceedings, while Warren and Sanders increasingly seem to be as antiwealth as they are anti-Trump.
If the country shifts to the far left in reaction to Trump, the stock market would almost certainly take a hit. It is impossible to know if that would be a short-term swoon without knowing whether the Democrats take control of the House and the Senate, thereby creating a horror movie titled “Nightmare on Wall Street.”
“It’s a black-swan event,” Michael Schwartz, Oppenheimer’s chief options strategist, tells Barron’s. “But it is one that everyone can see and hedge at a time when hedging costs are historically inexpensive.”
Schwartz has created an election countdown clock on an internal website he has created for his firm’s advisors. “We have to focus on risks that are not yet fully part of the market narrative,” he says.
The financial media seems to be focused on doom and gloom. Even if the coverage is sensational, or erroneous, the stories can create self-fulfilling prophecies. If enough people are talking about declines or hedging, it tends to create conditions that lead to a decline.
What to do? Should a maelstrom manifest, sell puts on quality stocks and take advantage of investor fear. Buy more of key positions. Initiate new ones, perhaps in E*Trade Financial (ticker: ETFC) and Interactive Brokers Group (IBKR). These companies may find it harder to remain independent following Charles Schwab’s (SCHW) planned acquisition of TD Ameritrade Holding (AMTD).
The merger news initially drove E*Trade’s stock lower, as investors dumped shares. Investors should take advantage of any weakness and buy the stock, and sell puts. E*Trade now has an acquisition target on its back.
Interactive Brokers barely budged on the news, likely because it is closely controlled by founder Thomas Peterffy. Investors could buy calls on Interactive Brokers and thus commit less money to an aggressive speculation that Peterffy may decide to cash out.
Both bets express a view that the online brokerage industry cannot exist in its current form at a time when competitors are becoming much larger and trying to price the industry out of existence.
Originally Posted on November 29, 2019 – The Market Fears a Democratic Sweep. Here’s How to Profit From It
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