Elections The Flame, Wall Street The Moth

Includes: IYF, VXX
by: Daniel Sckolnik

"Look at situations from all angles, and you will become more open." -- Dalai Lama

After being bombarded with what feels like a million years of presidential campaign news and advertisements, this coming week will finally bring closure to the identity of the next U.S. president.

That is barring, of course, any new variations on the old "hanging chad" parlor game.

Regardless of who is elected as the next commander-in-chief, Wall Street will probably react favorably to the fact that the uncertainty of the matter has been put to rest, at least for another four years. Once that question mark has been removed, the sideways tendency that has been reflected in the equity market could suddenly be replaced by a new, upward trend that could close out the year on a positive note.

That the trend has indeed been sideways in nature may come as somewhat of a surprise to many investors, as several recent deep drops into the red might leave them with a Bearish sense of direction.

However, back around the middle of August, the benchmark S&P 500 Index (SPX) sat at 1405. As of last Friday, approximately ten weeks later, the SPX closed at 1414. Similarly, the Dow Jones Industrial Average (DJIA) ended last week at 13,093. Ten weeks earlier, it sat at 13,164.

True, over the course of this time period the equity market has spent some time hitting 4% over the current levels, but sellers have kept both leading indexes from going any higher and have, at least as of last Friday, brought both the Dow and the SPX back to the mid-August levels.

So the market has indeed been more volatile than during the sweet summer uptrend, and the last several months could readily be defined as uncertain in nature. However, the buyers and sellers have effectively equaled out the equation over this period.

Ergo, sideways.

So, will the "final answer" to the question "Who is the next U.S. president" serve as enough impetus to power the market into a Bullish tendency?

It could be the case, if the relatively weak earnings season doesn't deteriorate much further than it already has, the recent bout of better-than-expected economic news out of Washington continues apace, and the eurozone remains neutralized by indecision.

But here's the rub.

Any resultant positive skew to the market, due to the decreased level of uncertainty that follows this week's election results, could easily prove to be short lived. Why? At some point, investors would recognize that the composition of Congress will likely have more power than the newly elected president, and if the makeup of the House and the Senate seems to indicate continued gridlock, uncertainty will return fast and furious.

At that point, the fear of diving off a "fiscal cliff' will return to the forefront of investor consideration, and the concern over the direction of tax rates and spending cuts will gain traction. Should that occur, a trend towards the downside will more likely occur, and the Bears will take the reins into the New Year.

What The Periscope Sees

Uncertainty could easily remain in effect throughout most of the week, and caution seems a reasonable approach to take until volatility decreases. Can a position be established that can benefit from a drop in volatility, while hedging against a possibility of increased uncertainty? That depends on the play.

One possibility is a short-term pairs trade that matches up the VXX with IYF.

IYF (Dow Jones U.S. Financial Sector Index Fund) sits atop the Sabrient SectorCast ETF Rankings, which ranks each of the ten U.S. industrial sector iShares (ETFs) by Sabrient's proprietary Outlook Score. IYF could benefit strongly by any clear positive move made in response to renewed confidence following the elections.

The VXX, which tracks the S&P 500 VIX Short-Term Futures Index Total Return, would benefit if volatility increases in the market, something that would likely occur if the signs point to continued gridlock.

So, go long IYF, but also go long the VXX, as this ETN (exchange-traded note) will generally move up as volatility increases, and usually drop if volatility decreases.

Normally, two longs don't make a right pair, but in this case, it should work as a reasonably effective hedged trade.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Business relationship disclosure: I wrote this article in my capacity as Senior Analyst for Sabrient Systems. I have no position in any stocks or ETFs mentioned, nor do I have any relationship with a company whose stock or ETF is mentioned.

Disclaimer: This newsletter is published solely for informational purposes and is not to be construed as advice or a recommendation to specific individuals. Individuals should take into account their personal financial circumstances in acting on any rankings or stock selections provided by Daniel Sckolnik or Sabrient. Neither Daniel Sckolnik nor Sabrient makes any representations that the techniques used in its rankings or selections will result in or guarantee profits in trading. Trading involves risk, including possible loss of principal and other losses, and past performance is no indication of future results.