PHOTO: US NAVY [PUBLIC DOMAIN], VIA WIKIMEDIA COMMONS
Picking up from my 3rd quarter CIO commentary, Team Trump is running out the field goal unit to attempt a 59-yard field goal in the final seconds of the championship. Team Clinton is up 21-20, so a successful kick wins the game for Trump. From this distance (the ball will be snapped from Clinton's 42-yard line), Trump's kicker has about a 31 percent chance of putting the ball through the uprights, and in turn, his team's owner into the Oval Office. This is what FiveThirtyEight and NFL statistics are telling us.
To state the obvious, the last month of this presidential campaign has been extremely volatile, with the release of the Access Hollywood tape in which Trump makes lewd comments about women, two raucous debates, and the FBI's reopening, and then re-closing, of its probe into Clinton's private email server. Through it all, the probability of a Trump victory fluctuated from about 23% a month ago, to 36% late last week, to 31% now, a day after the FBI re-cleared Clinton of criminal wrongdoing in regards to her emails, and a day before the election.
US Presidential Election Probabilities
Source: FiveThirtyEight
The volatility in probabilities gave us a peak into the markets' thinking on the candidates. While both ends of the political spectrum are calling for economic disaster should their candidate not win tomorrow, it's clear who the markets are afraid of winning—Trump. For the first time in my memory, markets are not pulling for the Republican presidential candidate. But this isn't surprising when one understands the economic and trade policy positions of the two candidates. In this election, it is the Democrat who has the more right-leaning, business-friendly policies ,while it is the Republican who has the more left-leaning, protectionist policies.
The chart below shows how US and international equities reacted positively to events that increased the chances of a Clinton victory (Access Hollywood Tape and re-closing of the Clinton FBI email probe), and reacted negatively to the event that increased the chances of a Trump victory (the reopening of the email probe).
Markets Prefer a Clinton Presidency^,2,a,b,c,d
Source: Google Finance
The VIXe (formally known as the CBOE Volatility Index, a measure of expectations of S&P 500 volatility over the coming 30 days) tells a similar story. One month ago in my quarterly commentary, I remarked at how calm the market was given what I perceived to be a reasonably significant (1 in 4) chance of a large negative event for the markets, a Trump victory. With the FBI's reopening of its probe into Clinton's emails on October 28, and in turn the chances of a Trump presidency, the VIX spiked to 22.5, just shy of the level it hit in the aftermath of the United Kingdom's vote to exit the European Union.
VIX Rises with Trump Victory Chances
Source: Bloomberg
From the market movements caused by the reopening, and then re-closing, of the FBI's probe into Clinton emails, we got a feel for how the markets may react tomorrow. The S&P 500's 2% decline as the FBI's probe reopening hit Clinton's election chances by about 12.5 percentage points, and today's 2% rebound on the re-closing of the probe, seems to point to a high single digit, to possibly a double-digit decline in the S&P 500 should Trump win tomorrow. Emerging markets would likely be hit even harder (particularly Mexico and China), and the US dollar would likely sell off by 3-5 percent against the safe-haven currency of Japan. Given today's market rebound and the expectation that Clinton will win tomorrow, we think that market moves to the upside will be modest, perhaps a percent or two for the S&P 500, and less than one percent for the US dollar-Japanese yen.
One event that could cause downside to the two presidential outcomes is if the Republicans retain control of the Senate. Democrats had been strongly favored to retake Senate control, but the Clinton FBI email probe has now pushed the odds over to the Republicans, as shown below in FiveThirtyEight's predictions:
Republicans Are Now Forecast to Retain Senate Control
Source: FiveThirtyEight
We think that any Trump victory would very likely be accompanied by Republican majorities in both the House (where Republicans are highly likely to retain control here regardless of who wins the presidency) and the Senate. We think that markets would react very negatively to such an outcome, triggering double-digit losses in the S&P 500. Not only would this outcome give Republicans full control of the Executive and Legislative branches of government, but would also likely usher out Paul Ryan and his more moderate and traditional brand of Republican leadership in Congress. This black swan event would greatly increase the likelihood of what investors so fear from a Trump presidency—economic disruptions and long-term damage from international trade wars, a large increase in government debt from tax cuts for the wealthy, and geopolitical instability as the US withdraws from its leadership position.
We think that markets would look negatively upon on a Republican Senate majority even if Clinton wins the presidency. Although cooperation between President Obama and the Republican-controlled Congress has been non-existant recently, we think it would get worse if the Republican Senate majority mandate is renewed. Usually a split in party control between the Executive and Legislative branches is positive for business and the economy, but an all out Cold War between the two is not. With several prominent Republican Congressman vowing to launch new investigations against Clinton, and to block her federal appointments (including for the Supreme Court), disfunction from Washington is set to continue if Clinton wins.
With market valuations high after a 7+ year bull market, and future risk-rewards scenarios weighted to the downside, AlphaGlider has been defensively positioned over the last year. We feel comfortable with whatever comes our way Wednesday morning. Not much left to do now but sit back, buckle up, and savor the last pitches from the candidates. 😉