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Elections Call for Investor Caution

A Republican victory in the midterm elections would be good for the stock market, but we're not betting on that outcome ahead of time.



) -- The most important variable for the stock market has temporarily shifted from stock price valuation to politics. All eyes are on Tuesday's midterm elections, with investors optimistic that the Tea Party movement can bring gridlock to Washington.

We believe the Republicans will win the majority in Congress. But I want to be sure of such victory before I redeploy capital in the market, and I have been selling down positions, including


(AAPL) - Get Free Report

2011 options, as I discuss below.

The Tea Party movement is an interesting phenomenon. If the Tea Party had been in control during the financial crisis, then

General Motors

would be dissolved, thebanking system would have been left on its own to collapse and the U.S. currency probably would have returned to the gold standard.

There is no question that this political movement is extreme. However, a dose of Tea Party mixed into a Republican majority in Congress with President Obama at the head of the executive branch could produce a wonderful tonic for the stock market.

If Obama shifts his policy towards the right as Bill Clinton did in 1994 and is successful at stimulating the economy through a more conservative agenda, the stock market shouldoutperform the historical 21% average return for a third-year, first-term Democratic president. The stock market currently is banking on this optimistic scenario.

But what if all doesn't go as expected over the next few days? What if undecided voters rebel against the extremism of the Tea Party and Democrats overcome the odds to win both the House and the Senate?

This scenario is unlikely, but some Republicans have grown a little nervous about what is happening in California. Republican gubernatorial candidate Meg Whitman is getting buried in the polls by rival Jerry Brown, while Senate candidate Carly Fiorina appears unable to budge Democratic incumbent Barbara Boxer.

This momentum could spread to the rest of the country. If it does, voters will be signaling that they're not happy with Washington but that they don't like the new alternative either.

I'll admit I would be much more comfortable with the projected outcomes of a Republican victory if the Tea Party movement were more moderate.

Given this bit of uncertainty about the election's outcome, however, the investor in me finds it prudent to watch the election play out before I commit new capital to the market.

With the market at the upper end of its trading range, and with Apple's ascent looking worn out, I think we could be in for a "sell the news" reaction even if the Republicans win the majority. If Democrats maintain a majority it won't be a "sell the news" reaction; it will be a "sell the surprise" over-reaction!

Don't get me wrong. As I stated above, I still expect Republicans to win a majority, and as soon as that victory is confirmed, I will look to reinvest my cash in the first half of November. For now, I'm content to sell down positions and wait.

Since we identified the Apple August low, our E Weather option LEAPStrades have generated gains worth locking in. It is a very special thing to be in tune with the action of a leadership stock like Apple. Our 12 trades sinceAug. 25 have yielded 11 winners and one loser:

  • 14% allocation of AAPL January 2012 $280 calls 29.00-64.40 (up 122%, holding)
  • 6% allocation of AAPL January 2012 $300 calls 23.35-52.70 (up 126%, holding)
  • 5% allocation of AAPL April 2011 $230 calls 35.80-65.50 (up 83%, sold on 9/23)
  • 5% allocation of AAPL January 2011 $270 calls 23.50-31.00 (up 32%, sold on 9/23)
  • 2% allocation of Netflix (NFLX) - Get Free Report March 2011 $120 calls 33.50-47.00 (up 40%, sold on 9/23)
  • 2% allocation of AAPL April 2011 $260 calls 26.60-43.00 (up 62%, sold on 9/23)
  • 5% allocation of AAPL April 2011 $290 calls 26.00-39.00 (up 50%, holding)
  • 5% allocation of NFLX March 2011 $150 calls 30.60-26.40 (down 14%, sold on 10/1)
  • 5% allocation of AAPL November 2010 $270 calls 22.00-42.00 (up 91%, sold on 10/19)
  • 5% allocation of AAPL November 2010 $290 calls 15.00-25.00 (up 67%, sold on 10/19)
  • 5% allocation of AAPL January 2011 $290 calls 22.00-29.00 (up 32%, holding)
  • 5% allocation of Baidu (BIDU) - Get Free Report January 2011 $100 calls 10.00-15.40 (up 54%, holding)

Overall, the Economic Timing portfolio mix of ETF's, stocks, options andcash is up 71.4% since Aug. 25.

At the time of publication, Schwarz was long Apple 2012 calls and Baidu and Netflix calls.

--Written by Jason Schwarz.

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Jason Schwarz is an option strategist for Lone Peak Asset Management in Westlake Village, Calif. He is also the founder of the popular investment newsletter available at Over the past few years, Schwarz has gained acclaim for his market calls on the price of oil, Bank of America, Apple, E*Trade, and his precision investing in S&P 500 option LEAPS. His book, The Alpha Hunter, is set to be released by McGraw Hill in December 2009.