The lead up to the election

There are now just 11 days until the US elections and it’s no surprise to see the S&P 500 in a holding pattern.

I have argued that the S&P 500 is happy to trade in a range of 2180 to 2116, where a break either side of this range would lead to new all-time highs, or a sizeable correction. With the election hanging over the market, it seems logical that no one is really committed to put new money to work in the equity market, despite Q3 earnings being better than expected.

For the record, of the 42% of companies that have reported quarterly numbers, 78% have beaten on the earnings line (by an average beat of 5.9%), with 65% beating on the sales line. We are even seeing 3% aggregate earnings growth. In theory, we could actually see quarterly earnings growth, after five consecutive quarters of declines.

I personally do not sit in the camp that the market is genuinely nervous about a December rate hike from the Federal Reserve (Fed) and feel that the more important issue is actually around the pace of hikes in 2017 and 2018. I don’t think market participants are too concerned by the recent bout of USD strength, as oil, bulks and precious metals look supported. However, it is the election that is causing angst and no new money is being committed until the result is known on 8 November.

A win for Trump is a green light for volatility

I am not sure traders are that concerned by the policy initiatives of either candidate. In my opinion it’s the political influence that can be placed on the Fed, potentially altering their likely anaemic path of future rate hikes that is absolutely key. That concern becomes real on a Donald Trump victory, where he has been very outspoken by their ultra-easy monetary policy setting. We simply don’t know how the world will look if he can convince the US Treasury that China are a currency manipulator. We don’t know what the world will look like if he tries to place trade tariffs on China, Japan, Mexico and other nations. If the US create a tax repatriation window, causing a wave of capital to be brought back into the US, and in turn aggressively pushing up the USD. What are the likely side-effects of a far stronger USD? Uncertainty is the biggest worry for markets.

Traders feel they have a reasonable grip on what a Clinton win would look like and ideally the markets would like see a Democrat-controlled Senate and Republican-controlled House too (this is the base case). Many see this scenario replicating the first four years of President Obama’s time in office, where very little was announced that genuinely rocked market sentiment. A Trump win would likely cause market volatility to rocket, with the S&P 500 and other developed markets likely to be hit hard in the short-term. Gold will rally strongly, while emerging market assets would be savaged, so put the EEM ETF (emerging market ETF) on the radar. If ‘Brexit’ was a two-day affair, I feel a Trump victory would lead to a period of sustained volatility, at least until market participants understand the relationship between Trump and the Federal Reserve. Recall, the Fed have basically been at the heart of markets for many years and they have fully dictated investment flows globally. So to put a destructive force in front of the Fed means panic, and where there is panic there is also opportunity.

So has Trump got a chance?

Never say never, and many still have the ‘Brexit’ vote fresh in their minds, while others continue to point out that both the UK referendum and US election represent a break from traditional politics and the status quo. The key point of difference being that the US election is an absolute belief that one man can change the fortunes of so many who are tired of subdued growth, limited opportunity and low productivity. In the UK, the vote to leave the EU was built on an ideology and certainly didn’t reflect a belief in Michael Gove or Boris Johnson! There are of course synergies in the two votes, built on a rejection of the establishment and the desire for change.

However, it is worth remembering that Clinton has been easily ahead in the national polls for a while now and for Trump to win we would have to see a full-blown systematic error in the polling. The polls in the US show a far greater lead for Clinton than the ‘remain’ camp enjoyed in the lead up to the UK referendum. The pollsters have Trump’s odds of winning anywhere between 4% and 15%, never in the history of the independent US has a candidate had to come back from such a deficit. Trump will need nearly every ‘undecided’ vote, which seems unlikely given his controversies.

Never say never

Traders can look at policy changes and how that impacts the US corporate landscape and here the healthcare and financials sectors have the most to gain or lose. Recall that Trump has been calling for a full abolition of the Affordable Care Act (ACA), while Clinton is keen to expand the program. There are also potential changes to regulation in the financial space, which could restrict the ability of banks to increase revenues.

However, if the Fed has been the driving force of all asset classes in the last few years and a key influence by which other central banks set policy too, then any force which affects their ability to set policy as they wish could arguably be a significant destructive force to markets. The markets don’t think Trump wins this election, but they are certainly not prepared to put new money to work in the lead up. Just in case of a re-run of ‘Brexit’.

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