By: Steve Smith
We’re often told not to mix politics with investing. Today’s action is bearing that out in spades. The stock market is ripping higher, following what at the moment is mostly inconclusive election results. How can the bulls be so bold if all we’ve been told is the market hates uncertainty?
The main reason seems to be that no matter who ends up being President, there will still be a split Congress with no clear mandate, which would lead to gridlock. As far as Wall Street is concerned, the most bullish part of gridlock is Biden’s plans to increase capital gains and corporate tax rates won’t come to pass. This is leading to a resurgence in high-tech growth stocks as the Nasdaq’s (QQQ) up almost 5% today. The VIX or fear index’s plunging 20%!
Investors that believed the polls of a blue wave began dumping shares in names like Microsoft (MSFT), Amazon (AMZN), and Zoom (ZM) — in which they had large gains to avoid the expected increase in capital gains — are forced to chase back to re-establish those holdings. A true example that during times of heightened emotions, or seeming inflection points, people have a tendency to want to take action or show they’re doing something. Sometimes this takes the form of wanting to ‘hedge’ or reallocate positions for possible bragging rights, regarding their predictive prowess. Other times, it’s simply a case of running scared in the face of the unknown.
The only predictions I was willing to make and act on was that implied volatility would collapse, following the election regardless of the result. The action surrounding this election also confirmed that the markets are more often right than people give them credit for. In the days leading up to election, all the polls and betting markets were predicting a blue wave. As stated above, it would’ve leaned toward a benefit for small-cap, infrastructure, and cyclical stocks while being a negative to health care, growth, and energy. But, the market seemed to sense that a divided decision was coming and QQQs continued to outpace the Russell 2000 (IWM) with healthcare holding firm. Today, those spreads are widening. All of this highlights that unless you enter an event with a defined plan, such as the Options360 iron condors (they were probability-based trades), you’re likely to end up making an emotional decision at the worst time.
Here are other times when emotion can lead to a disastrous attempt at market timing:
- Bear markets. Do investors panic and sell because stocks are going down or do stocks go down because people are panicking and selling? A little of both I guess. However, there’s a reason why volatility tends to cluster during down-trending markets. Emotions run higher when prices are going down because losses hurt far more than gains feel good.
When the stock market’s falling it feels safer to move to the comfort of cash. The problem is cash becomes addicting during volatile environments so it’s actually harder to put that money back to work even though your expected returns rise the lower stock prices fall.
- Bull markets. There isn’t nearly as much panicking involved with bull markets as you get during bear markets. However, the fear of missing out can become pervasive when stocks are going up for long stretches of time. And since we’ve seen the stock market get chopped in half twice this century, calling market tops is now a cottage industry.
- When you’re wealthy. This is similar to the plight of the retiree who needs to preserve capital but getting to the point where you’ve managed to save a substantial amount of money can shift your mindset from growth to preservation. Even if you continue to work and set aside money for the future, there are diminishing returns after a certain level of wealth is reached because any future savings won’t make much of a dent in your overall wealth. When wealth preservation trumps the need to build wealth, it can be tempting to time the market because the dollar amounts of your losses are so much larger than they were when you were in growth mode.
- Presidential elections. Yes, this bears repeating since politics are the new religion for many people today — so it seems like every four years, the drumbeat of election-based investment strategies, worries, and hopes grow louder.
We have just witnessed how everyone can get it wrong.
Steve Smith have been involved in all facets of the investment industry in a variety of roles ranging from speculator, educator, manager and advisor. This has taken him from the trading floors of Chicago to hedge funds on Wall Street to the world online. From 1987 to 1996, he served as a market maker at the Chicago Board of Options Exchange (CBOE) and Chicago Board of Trade (CBOT). From 1997 to 2007, he was a Senior Columnist and Managing Editor for TheStreet.com, handling their Option Alert and Short Report newsletters. The Option Alert was awarded the MIN “best business newsletter” in 2006. From 2009 to 2013, Smith was a Senior Columnist and Managing Editor for Minyanville’s OptionSmith newsletter, as well as a Risk Manager Consultant for New Vernon Capital LLC. Smith acted as an advisor to build models and option strategies to reduce portfolio exposure and enhance returns for the four main funds. Since 2015, he has worked for Adam Mesh Trading Group. There, he has managed Options360 and Earning 360, been co-leader of Option Academy, and contributed to The Option Specialist website.
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