As the world eyes the U.S. election entering its final stage, the stock market indices continue to trade with a bid tone. Nasdaq 100, Dow Jones or the S&P 500 trade close to their highs, albeit many players took some “chips” off the table.
For instance, the Nasdaq 100 index corrected from 12,500 to 10,750 in September, in what appears to be a profit-taking from the March-April bounce. In other words, bulls take some profit ahead of the big election day.
Complacency is expected next, with little or no market movement until we reach close to November 3rd. However, this year may be different than other election years. First, there is a pandemic hovering around. Second, the short speculating positions on the equity index futures are the highest in a decade.
Who would take such a risk, and why?
The Biggest Short Squeeze or the Dump of the Century
According to the CFTC data, large speculators are going all-in ahead of the U.S. election. The combined short exposure on the stock market index futures on S&P 500, Nasdaq 100, and Dow Jones is almost $50 billion. That is the most in over a decade, telling us that shorts have held their positions all the time the market bounced from the March-April lows. Moreover, they may have added at recent levels, especially considering that both the Nasdaq 100 and the S&P 500 made new all-time highs in the meantime.
As we come closer to the year’s end, many institutional investors will already start preparing the strategy for 2021. The U.S. election outcome is key for such preparation, as a change at the White House will likely trigger massive macroeconomic changes as well.
After the election day, as December comes, expect the short positioning seen now to ease. Most institutional players rebalance their portfolios towards the end of the trading year.
In other words, in the case the market reacts with a bearish move to the U.S. election outcome, expect these shorts to book profits as we head into the end of the year. Hence, the profit-covering will bring some support to a possible bearish move.
On the other hand, a post-election market rally will trigger an additional short squeeze. Large speculators are unlikely to hold their short exposure beyond the end of the year – they will take some losses to ease their exposure and regroup in 2021.
Therefore, in both cases, the election is bound to bring increased volatility on the stock market. That, in turn, translates into higher volatility on all markets, as the stock market drove the price action in financial markets for the entire year so far.