Investors should consider downside protection in face of U.S. election volatility, report says

Futures contracts indicate increased volatility around the Nov. 3 U.S. election, and investors may want to consider downside protection, a report from CIBC Economics says.

As financial markets complete their recoveries to pre-Covid record highs, they’re also starting to price in potential election outcomes. The campaign season began in earnest this week as President Trump accepted the Republican party nomination for president. The Democrats officially nominated Joe Biden at their online convention last week.

“Financial markets have already started to price in heightened volatility around the election day, but it may not be too late for investors to seek protection from large swings ahead,” the CIBC report says.

S&P 500 contracts show markets are anticipating volatility in both the lead-up to the vote and after the result is announced.

According to CIBC, polls show Biden leading Trump by around 9% – a gap that could be enough for the Democrats to also win the Senate. 

Still, the authors note there’s room for an “October surprise” to overturn conventional wisdom, be it related to the pandemic, protests against anti-Black racism, or investigations into the president’s financial and tax matters.

The report also raises the potential of a drawn-out legal battle after Nov. 3 to determine the winner.

“[B]uying downside protection might not yet be too expensive given what’s at stake, and how far markets have come,” the report says.

Option contracts on baskets of U.S. and Canadian energy stocks haven’t priced in election volatility, despite significant policy differences between Trump and Biden on climate change and energy, the authors state.

“That might be fertile ground in which to take cover from a 2020 October surprise.”

A report released earlier this month from National Bank Financial noted that Biden’s four-year, $2-trillion green energy plan is the Democratic nominee’s most expensive proposal.

The plan would move the economy to net-zero carbon emissions by 2050 by no longer using fossil fuels to create electricity by 2035, and requiring U.S. carmakers to only make electric vehicles starting the same year.

Biden’s plan would also tighten environmental regulations and reduce subsidies to fossil fuel companies, the report says.

The most market-moving outcome from Nov. 3, National Bank says, would be the Democrats winning the White House and both chambers of Congress.

“While the markets could be unsettled in the short term by such a clean sweep owing to the Democrats’ pledge to raise corporate/capital gains taxes and increase business regulations, we feel that the promise to continue spending would, all other things being equal, help stabilize markets,” the report says.

The most likely outcome, according to the authors, is Biden winning the presidency and Republicans holding on to the Senate.