Monday, February 3, 2020

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The Iowa Caucus will kick off the 2020 presidential election

The stock market entered 2020 on a high note and ended January with a thud.

The Dow dropped more than 2% on Friday and all three major averages suffered their worst January performance since 2016.

And while most Wall Street strategists expected 2020 to be another solid year for markets, the presidential election was widely cited as a major market risk for this year.

And on Monday, this risk begins.

In some ways, it feels like the 2016 presidential election never ended and ran seamlessly into the 2020 election. But now, whether you or not you agree with this feeling matters not: the 2020 presidential election officially begins tonight.

Monday’s Iowa Caucus begins the months-long process during which the Democratic Party will elect their candidate for November’s presidential election.

Markets, of course, have already started to react to incoming political news. Even if the reactions to date are somewhat muted.

Analysts at Goldman Sachs said last week in a note to clients that so far, health care stocks have tracked the polling ups and downs of the Democratic primary most closely. Particularly managed care names, which have traded inversely to the prediction market assigned odds that either Bernie Sanders or Elizabeth Warren could win the nomination. These companies stand to be most vulnerable if a Medicare For All-type legislation were to become a more realistic possibility.

“Among US equity sectors, Health Care stocks have traded most closely with the 2020 Democratic primary race so far,” Goldman’s team wrote in a note to clients published Thursday.

“The sector also shows the highest volatility risk premium and implied volatility ‘bump’ around Super Tuesday. Nine months ahead of Election Day, most other industries exposed to policy risk have demonstrated less correlation with shifting election probabilities.”

“However, many carry modest valuation discounts that likely reflect investor uncertainty. At the same time, thematic portfolios such as potential beneficiaries of infrastructure spending and firms with high small business revenue exposure have exhibited clear sensitivity to the political environment.”

Perhaps counterintuitively, Goldman notes that since 1970 broad market volatility has tended to be lower in election years than in other years. But with the dot-com crash in 2000, the financial crisis in 2008, and the market reactions to Brexit and Trump’s election in 2016 having bucked this historical trend, investor expectations for higher volume in 2020 may supersede historical trends around presidential elections.

And indeed, Goldman notes that the options market is *already* pricing a 2.3% move around Election Day.

[chart]

Work from Keith Parker and the equity strategy team at UBS, however, suggests markets might be underpricing the odds of both of the most likely outcomes — Joe Biden or Bernie Sanders getting the nomination — of the Democratic primary.

Ahead of the Iowa Caucus, data from FiveThirtyEight through Friday showed Sanders with a very slight lead over Biden, with the Vermont Senator polling at 22% in the state while Biden sat at 21.5%.

Nationally, Biden still has a clear lead, polling at 26.7% as of Friday with Sanders in a clear second-place position at 21.7%. Elizabeth Warren sits in third at 15%, according to FiveThirtyEight.

“Recent underperformance of the Biden basket pair is in contrast with his polls/odds while the sluggish performance of the [Sanders + Warren] basket pair has lagged the jump in odds,” UBS writes. “This suggests that there could be potential for bigger relative moves on primary results. The Trump basket pair has rallied with his approval.”

The firm also notes that polling surges from both Sanders and Warren have been, and are likely to remain, the primary drivers of market sensitivity to political outcomes early in the cycle.

“However,” UBS adds, “the sensitivities are likely to shift as the market gets new information, front runners change throughout the election cycle and issues are emphasized.”

By Myles Udland, reporter and co-anchor of The Final Round. Follow him at @MylesUdland

What to watch today

Economy

  • 9:45 a.m. ET: Markit US manufacturing PMI, January final (51.7 expected, 51.7 prior)

  • 10 a.m. ET: Construction spending month on month, December (+0.5% expected, +0.6% prior)

  • 10 a.m. ET: ISM manufacturing, January (48.5 expected, 47.8 prior)

Earnings

Pre-market

Post-market

  • Alphabet (GOOG, GOOGL) is expected to delivered GAAP earnings per share of $12.50 on revenue of $38.4 billion for its fiscal fourth quarter.

  • Hexcel Corporation (HXL)

Read more

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Coronavirus sparks biggest Chinese stock crash since 2015 [Yahoo Finance UK]

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