Investors aren’t quite ready to put this chaotic year behind them just yet. There’s one more lingering risk event to fret over: the final races of the 2020 elections that have spilled into next year.
While not as pronounced as the hedging seen around Election Day last month, options and volatility futures do signal elevated concern over potential market turbulence resulting from the results of the Jan. 5 runoff races in Georgia that will determine whether Republicans maintain control of the Senate.
Prior to the November vote, many considered a Democratic sweep of the elections to be among the most bullish possible outcomes for U.S. equities. Since then, however, the market has shown it’s grown comfortable with a potential continued split control of the government -- a backdrop that historically has produced strong returns.
“There’s no doubt, if you go from red to blue, you’ve got to price in something that looks less favorable because of markets liking gridlock, markets liking status quo,” said Phil Camporeale, managing director of multi-asset solutions for JPMorgan Asset Management.
The focus on the runoff -- and demand for hedges to protect against turbulence in its aftermath -- is centered on uncertainty over how exactly investors should position themselves ahead of a Joe Biden presidency. He needs Democratic control of the Senate to execute on an agenda that would boost green-energy companies at the expense of fossil-fuel producers, while likely leading to more economic relief packages and infrastructure spending. Yet it could also help him raise the corporate tax rate and heighten regulatory scrutiny.
“It is impossible to overstate how important these elections are for the size, scale, and speed of 2021 fiscal, tax, and regulatory policy,” Cowen analyst Chris Krueger wrote in a note on Dec. 21.
Hedges In Place
There are potential winners and losers in both scenarios and it’s debatable which would be a better scenario for the overall stock market over the longer term. But traders appear to be hedging against volatility that could erupt in the short-term if the Georgia results cause investors to pile into the perceived beneficiaries of the outcome and dump the perceived losers.
The hedging likely also reflects concern that even small surprises could create turbulence in an equity market that needs the general public to keep on investing after a spectacular run. The S&P 500 has surged 65% from its low in March, with an assortment of valuation metrics at their highest in a decade or more.
“The idea that fiscal policy and public buying could matter more than earnings and revenues -- sounds a lot like 2020, doesn’t it? -- is instinctively uncomfortable and supports above normal volatility persisting,” Julian Emanuel, equity strategist at brokerage BTIG, wrote in a recent note.
The runoffs in Georgia were triggered after no candidates for the state’s two Senate seats clinched a majority of the vote. Republican David Perdue is running for re-election against Jon Ossoff, while Senator Kelly Loeffler faces Democrat Raphael Warnock. Polls show a tight contest between the Republican and Democratic contenders, while the PredictIt betting market shows a small advantage to the Republicans. President Donald Trump’s last-minute demand for bigger payments to Americans as part of a Covid-19 relief package is also a wildcard that may affect the vote.