In this article, we will analyze the upcoming Democratic Party Primaries for the 2020 US Presidential elections from a markets point of view. We will start by introducing the Democratic Party primary system for electing the Democratic Party’s Nominee who will face President Trump on the 2020 elections, after introducing the primary concept we will introduce the major candidates and their policies. Following these, we will focus on how candidates and their policies can affect the US economy and the markets. We will end the article with trade ideas based on potential market volatilities arising from the Democratic Party candidate nomination process.

Structure of US Democratic Party Primaries

In the Democratic Party primaries and caucuses, the democratic party members in all states and territories of the United States decide on their so-called “pledged delegates” to go the Democratic National Convention. In the Democratic National Convention, these pledged delegates and other non-pledged delegates, so-called superdelegates, vote to decide their presidential nominee. The primaries elect 3,769 pledged candidates who, together with 765 unpledged delegates, make up the Democratic National Convention. The Democratic Party leadership has, for the first time this year, changed the rules of non-pledged delegates voting rules, mandating them to refrain from voting in the first-round ballot unless a candidate gets more than 50% of the votes in that first round. The new reforms also regulate how the Democratic National Convention shall handle the outcome of primaries and caucuses for three potential scenarios:

If a single candidate wins at least 2,268 pledged delegates: Superdelegates will be allowed to vote at first ballot, as their influence cannot overturn the majority of pledged delegates.

If a single candidate wins 1,886–2,267 pledged delegates: Superdelegates will be barred from voting at first ballot, which solely will be decided by the will of pledged delegates.

If no candidate wins more than 1,885 pledged delegates: This will result in a contested convention, where superdelegates are barred from voting at the first formal ballot, but regain their right to vote for their preferred presidential nominee for all subsequent ballots needed until the delegates reach a majority.

In a contested convention where no majority of minimum 1,886 pledged delegate votes is found for a single candidate in the first ballot, all superdelegates will then regain their right to vote on any subsequent ballot necessary for a presidential candidate to be nominated (raising the majority needed for such to 2,267 votes).

Therefore, it becomes apparent that the primaries held before the DNC are of extreme importance and set the stage of who will likely receive the nomination. Even more so this year with the changes to the voting rules at the DNC for the superdelegates.

The primaries are held from February through to June. However, the bulk occurs in February and March. Specifically the 3rd of March, the “Super Tuesday”.  At the Super Tuesday many states (including big states who has many delegates like California, Texas, Virginia, North Carolina, Massachusetts, Wisconsin) will be organizing their Democratic Primaries on the same day, we find this day as a potentially major event which markets could focus as it could be a pivot point for many candidates. Our trade ideas will be focused around “Super Tuesday”.

We will look at 4 candidates, Michael Bloomberg, Joe Biden, Elizabeth Warren and Bernie Sanders and their proposed regulation and the likely market reaction if they would win the primaries. From that, we devise a trading strategy on volatilities of certain sectors of the market in the time of when the major primaries are.

If we classify the major democratic candidates according to their political views, we see that there are two main types of candidates: centrists and leftists. The consensus is that Bloomberg and Biden are centrist candidates whom can be considered “market-friendly” due to the nature of their campaigns while Bernie Sanders and Elizabeth Warren can be considered leftists whom we might call not so market-friendly as they have been proposing more regulation, tech breakups and restrictions to private health insurance. We analyze candidates on major issues that might be linked to some sectors of S&P500 or the fiscal policy prospects of a potential presidency of these candidates, these issues are healthcare, financial regulation, technology and data regulation, tax policy, the environmental policy with an emphasis on fracking.

The Bloomberg Campaign

Michael Bloomberg, who is a well-known figure for people who follow markets, is the former mayor of New York City and he has been a top donor for many mainstream Democratic senators and congresspeople especially after the election of Donald Trump. It is noteworthy candidates he backed have been mostly centrists Democrats who heavily oppose Donald Trump and his policies while not endorsing socialist and sometimes extreme left (on US political standard) policies of some congresspeople such as Warren, Sanders and newly elected congresswomen Alexandra Ocasio Cortez. He is the latest major candidate to join the already crowded field of Democratic Primaries. As he has a relatively new campaign we do not have all the details of his policies. However, he has made his ideas and views on major topics concerning market are clear even before the announcement of his campaign:

Overall, he is more moderate and focuses his policy ambitions on topics such as gun control and climate change. Both of which he made donations before being a candidate.

Healthcare: He opposes Medicare for all as proposed by other candidates, claiming it would be unaffordable. According to Bloomberg 2020’s campaign website, a Bloomberg White House would further expand Obamacare and Medicare. The campaign does not state any controls or limitations on private healthcare. He has continuously stated that people should preserve the right to have private health insurance.

His campaign doesn’t list any further financial, technological and data regulation while it also doesn’t include any changes in corporate tax policies. He supports a tax system in which the super-rich, like himself, should pay more in taxes however he believes that a wealth tax would be unconstitutional.

He supports a green new deal while stating it would not put forth to high promises. Until now he hasn’t publicly proposed a ban or further restrictions on fracking.

He lists trade wars as a “failure of the US government.”, it should be a feasible interpretation that he would not pursue trade tensions as heavily as Trump does but also he could be a more trade-friendly president than other Democratic candidates like Warren and Sanders.

Overall, he is a moderate candidate who will probably have one of the biggest budgets for advertising his platform. His reputation, resources, and name make him one of the most important candidates for the nomination but it should be noted that he has already missed deadlines for early caucuses such as Iowa so for him to have a strong chance in the convention performing extraordinarily on Super Tuesday has significant importance.

Vice President Biden’s 2020 Campaign

Another candidate whom we could consider “market-friendly” is Joe Biden. Previously serving as vice president under President Obama he is one of the earliest candidates announcing their bid for the presidency. He is a strong candidate and he has led the polls since the primaries have started. He has a strong and well-known name due to his past political experiences. When it comes to his policies, we could say that he and Mr. Bloomberg have similar campaigns focusing on a centrist approach to solve problems while opposing Donald Trump and his policies.

He proposes, unsurprisingly, an extension of Obamacare and he portrays Obamacare as a gateway to “Healthcare for all”. He opposes insurance companies charging patients with pre-existing conditions more with respect to others as President Obama did. He doesn’t oppose private health insurance but he pledges to make healthcare insurance markets more efficient by extension and protection of Obamacare.

He supports a reevaluation of current fracking allowances to check and ensure their safety, he is in favor of a Green New Deal which would increase government spending to make the American economy more climate-conscious.

His experience as vice president and moderate approach also to business such as through his ideas about fracking make him a favorite. Not only from the democrats where he currently holds 33% of the polls but also Wall-Street.

Elizabeth Warren and Bernie Sanders

Especially after the election of Donald Trump, some members of the Democratic Party have moved to a much more progressive platform which many including candidates themselves consider socialist democracy. These Democrats are in favor of higher regulation towards big tech giants, big Wall Street Banks and many healthcare companies can also be concerned from this rise as they are advocating a much more serious approach to healthcare for all and more restrictions on how insurance companies can charge their clients. Two serious candidates of this point of view according to major polls are Senator Bernie Sanders and ex-Harvard Professor Senator Elizabeth Warren.

Bernie Sanders is an independent senator from Vermont. He is the longest-serving independent senator in the US. He describes himself as a socialist democrat and his campaign promises show this. He wants to introduce rent control to stop high property prices in urban areas and introduce taxes to curb speculative buying of property. This does not sit well with the real estate sector. But what is likely to be much more controversial for markets is his determination to re-introduce the Glass-Steagal act which was introduced in 1933 and repealed in 1999 after years of lobbying. It forces US banks to split between commercial and investment banking which would drastically reduce the capital which investment banks the like of Citi, JPMorgan and Bank of America have available to their balance sheet heavy operations. His views on trade are also noteworthy, he lists negotiating trade deals that help American families not multinational corporations as a priority. He expresses frustration towards the trade deals that US has signed in the last 30 years and pledges to renegotiate these deals. Last but not least, he proposes a fracking ban. It comes as no surprise that Bernie Sanders is viewed not to positively by markets.

Elizabeth Warren is the senior senator from Massachusetts and in many ways is on the same page with Sanders. For housing, she wants more federal funding to build more houses, thus posing a less drastic approach than Sanders. However, she does support bringing back the Glass Steagall act as well as increase the minimum wage to 15$ an hour. This is something that Sanders supports as well and has great support from many economists who argue that the minimum wage should be increased to overtime 22.50$ per hour and from then on be inflation-adjusted yearly. This is a proposal not new and should fix that the US minimum wage has not been adjusted for a long time. Warren also wants to introduce a tax the super-rich to bring more wealth equality to America. In addition to the wealth tax, she also has tax policies that might concern Corporate America. She pledges to introduce a “Real Corporate Profits Tax” of 7% to be applied to corporations that report profits above 100 Million USD. She claims that which such policy Amazon would pay 698 million in real corporate taxes while Occidental would pay 280 million. She also is a supporter of banning fracking. One of her most important policies is “Breaking up Big-Tech” which would potentially break up many of the tech giants to promote competitive markets. For the Glass-Steagall act and the progressiveness of her policies she is, by Wall-Street, also seen in a negative light.

How is the market pricing the elections?

We believe that the policies of Sanders and Warren can be highly problematic for healthcare, technology, and financial stocks. Because all of the candidates introduced in this article lead Donald Trump on polls we would expect some pricing reaction from markets. However, when we look at valuations of these sectors such concern is not evident. Here we will try to explain how the market pricing changes during the primary season, and we will try to formulate a trade idea to exploit such opportunities.

Lack of clarity on who will win the nomination: As it can be observed in the Predictit political trading platform contracts of all these four candidates currently trade at close levels and they all are below 50 indicating a lower than 50% chance for any single candidate to win the primaries. This is the exact opposite of the 2016 Democratic Primaries where Hillary Clinton had won the nomination easily against Sanders. We feel that especially Super Tuesday as a major event that could determine who gets to win the nomination. Assuming no other major market event and if the race stays this close until Super Tuesday we would expect meaningful market volatility around Super Tuesday.

Source: Predictit

Note: Red line represents Warren, the light blue line represents Biden, dark blue line represents Sanders and green line represents Bloomberg

In addition to the equity market volatility that might arise around Super Tuesday in case of a Sanders or Warren win, we could experience an increase in US borrowing and debt which could have treasury market consequences however we believe that Super Tuesday would still be too early for treasury markets to react to such news.

Studying the volatility surface for S&P500 can be a meaningful way to analyze if market participants are trading this potential date as a major marker event.

Source: Bloomberg

We can see demand from investors for downside protection, as implied volatility for options with a strike price below the prevailing spot price (moneyness < 100%) spikes significantly. Since this pattern holds for Mar-20 options it can be reasonable to say that this reflects investors’ concerns about Super Tuesday. Over the course of the past month, this uncertainty increased, as can be seen from the graph of the volatility skew.

As the volatility skew supports an argument that Super Tuesday might be an event that could spark market volatility the term structure of VIX can also be a place to see such evidence.

Interestingly, there is no evidence and on the contrary, there is evidence that the spread of Feb-20 and March-20 VIX futures are thinner than any two consecutive months. This presents an opportunity for those who believe that Super Tuesday can be a determining moment for Democratic Primaries and the policy differences between candidates could cause market volatility.

As we have described, Super Tuesday can be a pivoting point of Democratic Elections and the candidates who have good chances have significant policy differences. A Warren or Sanders campaign can be negative for technology, healthcare, and financial stocks. As these three sectors are major sectors of S&P500 high volatility within these sectors would lift the VIX. In such a case shorting Feb-20 VIX contracts and longing Mar-20 VIX contracts would be a profitable trade. As no major future on sector volatility exists we would have to stick with VIX to trade this via futures.

Another way to trade the Super Tuesday could be opening a long straddle trade (longing both a call and put option with the same maturities) before the event. However, the timing of the trade is critical due to capturing all the potential volatility arising from Super Tuesday.

Bocconi Students Investment Club does not endorse any of the candidates described. The aim of the article is to look at the factual economic data and discuss potential market developments.


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