By Saqib Iqbal Ahmed and April Joyner
NEW YORK, Oct 23 (Reuters) - With less than two weeks to go before the U.S. presidential election, investors may be placing too much confidence in a decisive win by Democratic challenger Joe Biden as his lead in opinion polls narrows.
Market participants have in recent weeks pulled back from bets that would benefit from election-related volatility while piling into assets that would benefit from a Biden win, including alternative energy shares and cannabis stocks.
As Biden's lead has narrowed in recent days, some market watchers worry that an unexpected victory by President Donald Trump, a Republican, or an uncertain election outcome could force the type of violent positioning unwinds that occurred in 2016, when investors were overwhelmingly positioned for a Hillary Clinton presidency.
In betting markets, Trump's chances of winning the election increased about 1 percentage point to 36.3% following Thursday's debate, but Biden maintains a significant lead, with a 64.4% chance of winning the election, according to data from RealClearPolitics.
"To some extent the markets are under-appreciating the likelihood of a Trump rebound here," said Karl Schamotta, chief global strategist at Cambridge Global Payments.
Following the election, traders expect the biggest market swings to occur in equities. Among the assets vulnerable to violent moves is the Invesco Solar ETF TAN.P. The exchange-traded fund has risen about 24% over the last month as investors anticipate that clean energy policies under a Biden administration would bode well for the sector.
Options prices suggest the ETF's shares could log a one-day move of as much as 11% in either direction once the election results are out, according to calculations by Christopher Murphy, co-head of derivatives strategy at Susquehanna Financial Group.
The technology-heavy Invesco QQQ Trust Series 1 ETF QQQ.P and the S&P 500 tracking ETF SPDR S&P 500 ETF Trust SPY.P are each primed for a move of about 3% to 4%, Murphy said.
An unexpected Trump win could also hit currencies such as the Mexican peso MXN= and Russian ruble RUB=, while boosting the battered U.S. dollar, analysts said.
Utility firms, tax-exempt municipal bonds, industrials and material stocks may also be vulnerable, said Justin Waring, investment strategist at UBS Global Wealth Management.
Treasury yields, which move inversely to prices, rose to four-month highs on Friday, a day after Biden and Trump squared off in a final debate that some observers said was unlikely to improve the incumbent's re-election prospects.
Some investors believe a Biden win could usher in higher spending and weigh on bonds.
Some market watchers have also noted that investors, while still far more hedged against markets swings than in the 2016 election cycle, have pared bets on wild stock market gyrations over the past two weeks.
S&P 500 options expiring in December are implying a more muted level of stock swings than they did just two weeks ago, suggesting expectations for market turmoil following the election have come in.
Equity and interest-rate options "are pricing in that Biden wins the presidential election," said Amy Wu Silverman, equity derivatives strategist at RBC Capital Markets. "They're fairly complacent on that, as well as the idea of a 'blue sweep.'"
While the market fears of election-related volatility have receded somewhat, by no means have investors sounded the all-clear signal. The Cboe Volatility Index, known as Wall Street's "fear gauge," stands above 28, significantly higher than the low to mid-teen range it was trading in just prior to the 2016 presidential election.
An uncertain or contested election would likely result in even more sustained volatility. The S&P 500 slipped as much as 10% in the weeks following the 2000 election, before the Supreme Court decided the hotly-contested battle between George W. Bush and Al Gore for the presidency.
Such a period of uncertainty could hit the market's biggest winners, including the technology and momentum stocks that have been a key driver of the S&P 500's rebound, said Joseph Amato, president and chief investment officer of equities at Neuberger Berman Group PLC.
"If you have a risk-off environment because of a contested election then you probably have vulnerability on those stocks that have done the best," Amato said. "Quite often in a risk-off scenario you often sell your big winners first."
(Reporting by Saqib Iqbal Ahmed and April Joyner; Editing by Ira Iosebashvili and Nick Zieminski)
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