Alfred E. Neuman was a fictional character in Mad magazine. He was cross-eyed, gap-toothed and always smiling. Neuman was never bothered by any setback.
Neuman’s motto “What, me worry?” could be the catchphrase of the equity market. The market has greeted the election uncertainty with glee. Technology stocks have powered yesterday’s rally. The Nasdaq 100 is up 4%, while the S&P500 rose 2%. Even the suspension of Ant Group Co’s IPO was brushed aside.
However, a tortured battle looms. As Joe Biden closes in on victory, President Trump has vowed to fight to the finish. The relentless Trump has already petitioned the courts. There may not be a resolution before the inauguration, which is 76 days away.
The chaos could wipe the smile off Neuman’s face. It could also wipe out the S&P 500 gains. There is a distinct possibility of violence. Come Jan 20, Trump may not vacate the White House, even after Biden has been sworn in. The use of force may end the impasse.
The last time that there were fears of violence in an election dispute was in 1876. The popular vote was won by the Democratic candidate Samuel Tilden, but his Republican opponent Rutherford Hayes claimed victory in the electoral college. Hayes claimed 20 electoral college votes, which Tilden disputed.
In those days, the gap between election and inauguration was four months. A crisis crippled commerce. The stock market sunk sharply as war fears rose. Investors hoarded gold and silver, which are now known as risk assets.
The matter was finally resolved in Hayes’ favour on March 5, 1877. The clincher was the outgoing President Ulysses Grant’s threat to forcibly prevent Tilden’s inauguration.
The situation is even more dangerous today. Unlike Grant, the sitting President Trump is not a neutral arbiter, but the chief player in the dispute. As the commander-in-chief, there are plausible scenarios that could end in bloodshed.
Finance has progressed since 1876. Investors during uncertainty have more options than hoarding jewellery.
One striking innovation is the VIX Index, also known as the fear gauge. The VIX Index measures the market’s expectation of 30-day, forward-looking volatility. The volatility is implied by the prices of S&P options.
The Index has its origins in the work of two finance professors Dan Galai and Menachem Brenner, who wrote about it in 1989. This inspired the Chicago Board Options Exchange (CBOE) to create the Vix Index.
Typically, the VIX Index spikes when the S&P500 declines sharply. In bull markets, the VIX drops steadily. When the market collapsed from Feb 27 to March 18, the VIX rose four-fold. On March 18, many index stocks like Facebook and Apple hit their one-year lows. Today, the VIX is hovering at a 65% discount to its March high.
The direction of a market is hard to predict. However, the VIX is a rough proxy for fear. There are VIX ETFs to help players to profit from rises in the expected volatility of the S&P500. These include ProShares Ultra VIX Short-term Futures ETF and Lyxor S&P 500 VIX Futures Enhanced REIT. There are also VIX indices that track assets ranging from commodities to currencies.
Trading volatility has become one of the most popular ETFs in 2020. This year more than US$1.5 trillion ($2 trillion) derivative bets were made. This is five times the figure in 2010, according to the CBOE.
The VIX Index has inadequacies as a hedge. It only measures 30 days of implied volatility. It does not always rise with a sell-off. For instance, it fell during the September sell-off. Also, it rolls over after a spike in volatility. It’s not like holding a stock.
Investing in solid consumer names could serve as a hedge. For instance, the highly branded consumer giants like Nestle and Unilever sell essential items such as groceries and personal care. Their brands include household names like Lux, Kit Kat and Rinso. Their earnings have been resilient in the Covid-19 carnage. At a dividend yield of 3%, they seem enticing.
Other traditional stocks that could weather the storm include Campbell Soup. The US giant was one of the few consumer names that prospered in 2008, as soup was viewed as a comfort food. However, investors will need more than soup if the election defies resolution. Even Alfred E. Neuman’s smile may turn to a frown.
Nirgunan Tiruchelvam is head of consumer sector equity at Tellimer (Exotix Capital)
