While anticipation of the election cycle's 'can't lose' perspective on markets is widespread, there is a somewhat more concerning cycle that accompanies it that we suspect will be much more critical this election year than in recent times. As Barclays notes, the 'policy uncertainty cycle' into presidential elections is very notable - especially in the 4-5 months immediately prior to the election. The reason this is concerning is simple - in recent years 'policy-uncertainty' has been extremely highly correlated to market-uncertainty (VIX, for example) suggesting that we are due for a rather large risk flare over the next few months. Believing in the omnipotent capabilities of central banks (or governments) to levitate markets in an election year is all well but if the path to that 'outperformance' includes a 20% dip, does anyone stay to benefit? With fiscal drags of $200bn to $650bn based on election-outcomes, it seems the policy-uncertainty cycle is not priced in at all.
The Policy-Uncertainty cycle is clear...
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and policy-uncertainty is dramatically correlated to risk flares...
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especially notable this year given the deep polarization and potential 'fiscal cliff'...
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Source: Barclays