Will low volatil­ity get Trumped?

Financial Mirror (Cyprus) - - FRONT PAGE - By Louis Gave

As we en­ter the fi­nal stretch of the ex­haust­ing US elec­toral cy­cle, the sin­gle most im­por­tant ques­tion con­fronting in­vestors may well be whether the cur­rent low volatil­ity en­vi­ron­ment for equities, bonds, and ex­change rates is de­pen­dent on politi­cians or not.

Clearly, with the VIX hov­er­ing around 12, and with volatil­ity in ex­change rates barely no­tice­able, fi­nan­cial mar­ket par­tic­i­pants are mak­ing one of two pos­si­ble bets:

1) Hil­lary Clin­ton will be elected, and poli­cies com­ing out of Wash­ing­ton will be “busi­ness as usual”, or

2) Don­ald Trump gets elected, and the im­pact on fi­nan­cial mar­kets will be muted.

Both th­ese views are highly com­pla­cent. At Gavekal we are not po­lit­i­cal pun­dits, but those who are, like Nate Sil­ver, typ­i­cally ar­gue that Hil­lary Clin­ton is still the favourite to carry the day on Novem­ber 8 (by 58% to 42% at the time of writing).

Still, the shift in mo­men­tum over the past few weeks makes it look like an­other med­i­cal “episode”, or a poor de­bate per­for­mance, could see Hil­lary’s lead disappear in less time than the Clin­ton Foun­da­tion keeps its for­eign donors wait­ing.

Be­hind the poll num­bers lurk two ma­jor ques­tions. The first is whether the peo­ple who voted so over­whelm­ingly for Barack Obama—mi­nori­ties and young peo­ple—will bother to turn out this time around. They did in the last two elec­tions. But back then the demo­cratic can­di­date was cool, ex­cit­ing, even in­spi­ra­tional: qual­i­ties that few would as­cribe to Hil­lary Clin­ton. In 2008 and 2012, for the first time ever, the turn-out was higher among African Amer­i­cans than among white Amer­i­cans, with around 96% pulling the lever for Obama in 2012. Will Hil­lary Clin­ton be able to mo­bilise such a turnout, with such a per­cent­age skew?

The se­cond ques­tion is whether there is a “Le Pen ef­fect” at work. In France, the Na­tional Front typ­i­cally at­tracts 2% to 4% more votes on the day than the opin­ion polls an­tic­i­pated. This re­flects the fact that no one brought up in po­lite so­ci­ety wants to come out as sound­ing na­tivist, Is­lam­o­pho­bic, bor­der­line racist etc. A sim­i­lar ef­fect was ap­par­ent in the Brexit vote, which ac­cord­ing to the polls the “Re­main” camp was des­tined to win by a mar­gin of any­where from 5pp to 8pp. In the event it lost by 48% to 52%. In other words, if the polls ap­pear close on the day, then per­haps in­vestors should brace them­selves for a Trump win.

But would a Trump win even mat­ter? Dis­cussing this ques­tion with clients over the past few weeks, I have heard the fol­low­ing ar­gu­ments:

- A Trump win may be a very pos­i­tive de­vel­op­ment for mar­kets.

In­ter­est­ingly, this view was ad­vanced by some of our more left wing clients (or at least by those who usu­ally like the “more gov­ern­ment” so­lu­tions pre­sented by Ana­tole). Their logic is that mon­e­tary pol­icy has reached its limit, and that what the US (and the rest of the world) needs is more Key­ne­sian-style fis­cal stim­u­lus. Un­for­tu­nately, if Hil­lary wins, she will en­ter of­fice as the least pop­u­lar pres­i­dent ever elected and her chances of get­ting any ex­tra spend­ing through a Re­pub­li­can Con­gress are slim to none (and Slim just left town). On the other hand, Pres­i­dent Trump would have none of the usual Re­pub­li­can “in­tel­lec­tual hang-ups” and could press ahead with gov­ern­ment spend­ing on ev­ery­thing from ed­u­ca­tion and healthcare (a sin­gle-payer sys­tem?) to in­fra­struc­ture and do­mes­tic se­cu­rity. While this is a pos­si­ble sce­nario (al­though it would en­tail Democrats hold­ing their noses and work­ing with Trump, which is not a given), a mas­sive ex­pan­sion in the fed­eral gov­ern­ment is hardly an ex­cit­ing prospect. As Charles Gave has shown time and again, the higher gov­ern­ment spend­ing, the lower P/E ra­tios.

- A Trump vic­tory would not mat­ter much be­cause the checks and bal­ances built into the US sys­tem would se­verely cur­tail his abil­ity to act like “a bull in a china shop”.

This may be true on the do­mes­tic front (as­sum­ing a GOP-con­trolled Con­gress proves even half as op­posed to fed­eral gov­ern­ment ex­pan­sion un­der Trump as it was un­der Obama). Still, there are two points of con­cern: the first is that Obama has set a prece­dent in by­pass­ing Con­gress by is­su­ing ex­ec­u­tive or­ders: a prece­dent that Pres­i­dent Trump would surely be only too happy to build on (as would Pres­i­dent Clin­ton). The se­cond is that al­though the US con­sti­tu­tion ties the pres­i­dent’s hands on do­mes­tic mat­ters, it gives the White House a much freer hand when it comes to “deal­ing with pesky for­eign­ers”. And Trump’s pro­pos­als for deal­ing with pesky for­eign­ers are un­de­ni­ably the most trou­bling el­e­ment of his plat­form.

- Ev­ery­one was con­vinced that Brexit would trig­ger a dis­as­ter, but it didn’t.

So why should we worry about Trump? This view holds that politi­cians no longer mat­ter for mar­kets; the only thing that counts is what cen­tral banks are do­ing. This ar­gu­ment was most preva­lent in Europe, where clearly some in­vestors got burnt sell­ing into the im­me­di­ate post-Brexit sell­off, and have de­cided not to make the same mis­take again a few months later. This at­ti­tude may prove too com­pla­cent sim­ply be­cause Brexit has not hap­pened yet, and may not for a few years, so it could well take a while for the pos­si­ble mar­ket con­se­quences to be felt. In con­trast, the pro­tec­tion­ism pro­posed by Trump could start shak­ing up global in­sti­tu­tions—the IMF, WTO, NAFTA—pretty much from the get-go, as could his iso­la­tion­ism (would NATO sur­vive?). Would cen­tral banks re­ally be pow­er­ful enough to cush­ion the volatil­ity trig­gered by mas­sive changes in trade pol­icy, for­eign pol­icy, fis­cal pol­icy, do­mes­tic pol­icy? Or would the im­pacts sim­ply be too big for the Fed­eral Re­serve/Bank of Ja­pan/Euro­pean Cen­tral Bank to cush­ion them all si­mul­ta­ne­ously?

In a re­cent pa­per, Charles Gave re­viewed the so­ci­etal changes that, to a large ex­tent, ex­plain the rise of Trump, Le Pen and oth­ers. What is amaz­ing about the cur­rent US elec­tion cam­paign is that the po­lit­i­cal map is be­ing re­drawn in front of our eyes. Many of the his­tor­i­cal be­liefs on which the Demo­cratic Party and, to an even greater ex­tent, the Re­pub­li­can Party were built are be­ing blown to smithereens. One might have ex­pected fi­nan­cial mar­kets to look on th­ese de­vel­op­ments and the un­cer­tain­ties they im­ply with some trep­i­da­tion. But far from it; mar­kets have been be­hav­ing as if the cur­rent po­lit­i­cal cy­cle is as nor­mal as it has ever been. I fear it isn’t—and that volatil­ity mea­sures will pick up head­ing into the elec­tion. Af­ter all, this vote could very well end up trans­form­ing the post-World War II global ar­chi­tec­ture, and it is quite pos­si­ble that one or more of the WTO, NAFTA, the UN, IMF, World Bank or NATO will not sur­vive a Trump pres­i­dency, at least in their present form.

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