Now's No Time to Form Emotional 'Bonds' With Your Candidate

As I am writing this, the U.S. presidential election is too close to call. But the markets are moving significantly on the results we have so far. As of around 9 a.m.m on Wednesday, the 10-year Treasury has declined in yield by over 10 basis points, which if that held, would be the largest single-day decline since March 27. Other markets have been volatile, with the dollar initially surging in Asia, only to give up all those gains and is now currently slightly weaker. Stocks are up solidly, but also bounced around quite a bit overnight. Given that bonds are my beat, here are my thoughts about how I'm investing now and how I'm going to read new information about the election results.

Don't Be Emotional

I wrote this last week, but I think this is my single best piece of advice: Don't let your personal politics influence your trading. You personally were likely hoping for one outcome or another going into Tuesday night, and that's obviously your prerogative. But markets aren't ideological. Too many people get bulled up (or become overly bearish) just because their party won. That's a great way to make a lot of trading mistakes.

Furthermore, politics is extremely difficult to predict, even after elections. You don't want to be betting on Congress passing any given measure or not passing any one, because as political winds change, so do legislative priorities. You can lean one way or the other, but make sure your whole bet isn't about politics.

Treasuries Moving on the Senate

I also remarked this last week, but it is all the more important now. The Treasury market had been selling off in late October, not on the race for president, but on the one in the Senate. The logic was that a blue wave meant both a near-term Covid stimulus and a large infrastructure deal in the intermediate-term.

Now it appears that control of the Senate will probably hinge on a razor-thin margin, with possibly the balance not known until the Georgia run-off in January. Regardless, we're obviously not getting some kind of blue wave that would allow Democrats to easily pass large spending measures. So, Treasuries are rallying Wednesday morning as the market tries to price out any kind of large stimulus program.

Readers know I've turned bearish on Treasury bonds over the last couple months based on core economic fundamentals. As the Treasury market continued to price in a Democratic sweep, my bearish Treasury position was working. But, as I said above, I wouldn't have put on any kind of position based Congressional spending packages. So in a sense, my positioning was right for the wrong reasons. That kind of situation can make you nervous, but my process is to stay in my preferred longer-term positioning. In this case, I was aware that an election that left the Senate in GOP hands (or even barely in Democrats' hands) was plenty likely, and if it happened, Treasuries would reverse for some period. But my core thesis remains intact: I don't think the economy needs fresh stimulus to keep growing, and if growth continues, eventually inflation pressure will build. I'm happy to be patient and ride out volatility as long as I still believe in my core thesis. 

The violence of this Treasury reversal has all the markings of a short-covering rally. In recent days, chatter was floating around the bond market that there was a "Big Short" in Treasury bonds, likely coming from hedge funds. It appears this is getting painfully closed out. Given this, I'm even less worried about what Wednesday's rally says about my longer-term thesis. As I write, the 10-year is trading at 0.77%, which only retraces two weeks' worth of rising rates. Basically, now it is as though the big surge in yields from about 0.75% to 0.90% didn't happen, even despite a slew of positive economic news between then and now. So, I still like being underweight and/or short duration.

Credit Remains a Good Play

Again, I don't think the economy needs more government spending to keep growing. We can argue about whether more spending would be better policy or not, but we will keep growing with or without it. That sets up to be a pretty good environment for corporate credit, especially investment-grade. Credit doesn't need strong growth to work, just the economy chugging along is enough. I personally prefer investment-grade to high yield here, because investment-grade can afford short-term disruptions from rising Covid cases, whereas some junk-rated firms may not have that luxury. In addition, the demand dynamics between investment-grade and high-yield are different. There are trillions in high-quality bond buyers that are willing to transition from government bonds to higher-quality corporates to get a little extra yield. Those kinds of buyers typically wouldn't go into high-yield. That dynamic makes the path for outperformance just a bit easier for investment-grade bonds vs. junk bonds. 

In essence, this positioning I'm describing is long investment-grade credit and short Treasury bonds. Even on a day like today, that positioning is working OK.

Municipals

This is one other sector that was an expected beneficiary of a blue wave, as it was thought that marginal tax rates would go up and therefore make tax-exempt munis more valuable. It is too soon to tell if that market will suffer any kind of reversal, as munis generally don't trade often enough to see in real-time market moves. Traders I've talked to suggest that muni yields are lower Wednesday, but probably not keeping up with Treasuries. Even that doesn't mean very much, since munis almost always lag Treasury bonds on high volatility days. This is therefore a sector we'll need to watch carefully over the next several days as both the election and the move in Treasury bonds shakes out.

At the time of publication, Graff was short 10-year and Ultra-10 year Treasury futures.