Obama Pocket Kings, Romney Pocket Queens?

November 5, 2012
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So Tuesday is the Presidential election. What does this mean for markets?

Various odds makers have the election all sown up for President Obama. The controversial New York Times blogger Nate Silver has Obama’s re-election odds at 86 percent, and Irish spread-betting firm Paddy Power is paying out on Obama bets two days early as a form of publicity stunt.

The notion is that, even though the popular vote is deadlocked, Obama is registering a near-insurmountable advantage in electoral college votes. This makes the odds of  a Romney upset highly unlikely — but certainly far from impossible.

If the bookies’ electoral college math is right, here is a way to visualize from a poker perspective: Imagine Obama pushing all in with pocket kings preflop, and Romney with pocket queens. Well over 80% of the time, kings will be good. But can a third queen, a four-card flush, or a four-card straight to the queen materialize by the river? Absolutely.

Sticking with poker, the worst possible outcome would be a draw — if, say, a five-card straight or five-card flush came out, forcing both candidates to “play the board” for a tie.

How would this look in election terms? Imagine some kind of ‘hanging chad’ type incident in which recounts were demanded due to closeness of the popular vote — or a nail-biter in a key swing state. That is definitely a lower probability scenario… but again, not out of the question.

Also horrible, politically speaking, would be the event of Obama winning via electoral college with Romney taking the popular vote. If that happened, rancor would go through the roof… and potential odds of logically resolving the ‘fiscal cliff’ would drop correspondingly.

We don’t have a dog in this fight, but none of this is good for markets…

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Speaking of which, Friday’s reversal was an ominous sign for bulls… after a hearty push away from danger levels, the major indices closed out the week right back in the danger zone, with bearish engulfing failure-to-launch type patterns adding to the gloom.

Bulls are hopeful that this rally can be extended, but the whole market feels balanced on a knife edge. Upcoming 2013 looks to be a year of trials and troubles, with most of the ‘hopium’ supply already used up.

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On the bullish side of the coin you have:

  • Firming US consumer data
  • Rising hope of US recovery strength
  • Hope of ‘Sandy’ stimulus
  • Seasonal favorability
  • Budding housing recovery
  • Possible China rebound

But on the bearish side you have:

  • Still ominous technicals
  • Deteriorating corporate revenues
  • Long-term spending fallout from Sandy
  • Vulnerable corporate profit margins
  • Risk of fiscal cliff deadlock
  • Further Europe / China risk
  • Diminishing stimulus returns

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Another interesting story is the firming of the $USD and the deterioration of the euro — all in all not a bullish sign…

We are long the dollar from pre-breakout levels (via UUP) and noted last week it was odd to see stocks switching to “risk on” mode even as the greenback strengthened. But with Friday’s equity reversal, intermarket relationships may be getting back to “normal” again…

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The other unfolding story is the mounting weakness in precious metals, which befits our ongoing skepticism and suspicion that the whole precious metals pop may have simply been a Bernanke headfake… a sort of hope jag in reverse (based on the hope that central bank action would power precious metals through the roof).

As we have said repeatedly,  the precious metals case just doesn’t add up at this juncture… maybe later but not now… and a 200 EMA submersion is saying the same thing loud and clear.

In the Live Feed (where we trade with real capital and share our positions) we are building out our short roster this week, with a number of individual equity names attractive on the bear side.

There are no guarantees markets will decline further post-election, of course, but this is an odds and probabilities game, and that’s the way risk / reward is tilting right now… if you would like to see our trade rationales, position sizing etc in real time, check out the Mercenary Live Feed.

JS (jack@mercenarytrader.com)

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