Risk Parity Market Environment About To Change, Trump Volatility Will Return: BAML

With polls showing Presidential candidate Donald Trump creeping ever closer to rival Hillary Clinton, who appears to be taking a defensive wait out the clock keep head down strategy, a Bank of America Merrill Lynch report says Clinton’s lead will continue to narrow. In fact, there will come a point for market where political concern, benign for most of the summer, will revert to volatility. This won’t look pretty for risk parity strategies, the report projects, breaking the calm during a relatively strong year for the strategy.

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Risk parity – Markets are pricing in perfection, a Clinton victory with Republican control of Congress

Last Friday’s sharp loss for the risk parity strategy, a rarity in a world of calm, is not a one off event. For those who watch algorithmic market environments, get ready because the short volatility environment is likely to give way to political concern before the election.

The bank report didn’t address algorithmic market environments but did note an NBC News poll out Tuesday that noted the new and improved Trump chipping away at Clinton’s assumed insurmountable lead. After a series of historic gaffes and a change in campaign management, Trump closed the gap by two points overall. With Clinton still leading 48% to 42% — some polls even show a closer gap — and yet the prediction markets pointing to an overwhelming 88% chance of the corporate-backed Clinton winning, BAML’s FX and Global Rates Strategist David Woo likes the mean reversion trade.

“History tells us to expect Clinton’s lead to narrow and volatility to rise in the final stretch of the elections,” Woo writes in an August 26 Cause and Effect report titled “Pricing in a perfect gridlock.”