Presidential elections often create volatile market conditions. But once the elections are resolved, as in the Biden Presidency, it allows for relief rallies. Based on market psychology or behavioral finance, uncertainties are often the culprit for investor indecisiveness. With more clarity, it is reasonable to expect the sideline money (cash) and defensive money (fixed income) to return to the marketplace. Although traders and investors may have priced in the favorable news as evidenced by last week's impressive rally, the risk-on trade appears to have carried over today, suggesting the rally may have more legs entering into the seasonal strength period.
This year market sentiments have flipped back and forth between periods of bullishness (risk-on) and periods of bearishness (risk-off). Headline news, geopolitical announcement, economic concern, pandemic uncertainty, and the recent political risk of a contested election impacted market sentiments. The collective risks have weighed on the psyches of traders and investors for most of the year.
So, is the recent sharp market rally a temporary Biden election bump, or is it still the start of a new risk-on scenario?
When investors are generally optimistic and upbeat about the outlook of the economy, geopolitical, and financial conditions, riskier assets tend to perform well in what is commonly called a risk-on market. On the other hand, when investors are pessimistic or confused, they tend to favor safe and defensive assets in what is known as a risk-off market.
Growth (SGX), momentum (MTUM), small-caps (SML), emerging markets (EEM), economically sensitive cyclical stocks (XLY), and high yielding fixed income securities (HYG and JNK) are the typical risk-on investments.
Low-beta, income and high dividend-yielding securities, utilities (XLU), consumer staples (XLP), gold (GOLD), US Dollar (USD), Japanese Yen (JPYUSD), Swiss Franc (CHF USD), and high quality safe fixed income securities such as US Treasuries (TNX) are risk-off investments.
The Dow Jones Industrial Average (INDU) and S&P 500 Index (SPX) held onto much of their gains by the end of the day (11/9/20) but did close off their session highs. Both markets traded to intraday record highs earlier in the trading session before slipping into the close. Nasdaq Composite Index (COMPQ) and some of the Technology sectors (XLK) faded by the end of the day with slight daily losses.
Technically speaking, since investors tend to vote with their wallets and pocketbooks, confirmations are often necessary to solidify a change in market sentiments. If this is indeed the start of the next sustainable and longer-lasting bull rally, then risk-on securities will need to take over market leadership roles. Key technical base breakouts and recording new all-time highs would greatly help to confirm the risk-on market scenario.
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