De­te­ri­o­rat­ing price mo­men­tum, ris­ing po­lit­i­cal risk

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

As of Fri­day’s close the S&P 500 had recorded nine con­sec­u­tive down days, fall­ing back to its 200-day mov­ing av­er­age. One can point the fin­ger for this pull-back at any of sev­eral fac­tors: broadly dis­ap­point­ing earn­ings (ex-fi­nan­cials), ris­ing for­eign ex­change vo­latil­ity, higher long term in­ter­est rates and, of course, ris­ing po­lit­i­cal risk. Un­for­tu­nately, none of these forces looks set to abate any time soon, per­haps not even po­lit­i­cal risk.

Leav­ing aside earn­ings, or the move higher in bond yields, over the com­ing days most in­vestors’ out­looks are likely to be dic­tated by the rise, or fall, in po­lit­i­cal risk. Now, as a rule, we at Gavekal tread war­ily on po­lit­i­cal mat­ters, for not only is our broader read­er­ship split fairly evenly be­tween left and right, so is our own part­ner­ship. Con­se­quently, we try to avoid get­ting in­volved in fruit­less po­lit­i­cal de­bates. Still, with the stakes in the up­com­ing US elec­tion so high, it is ob­vi­ous that over the com­ing week the Amer­i­can voter will have a dis­pro­por­tion­ate im­pact on fi­nan­cial mar­kets. As I see it, there are four po­ten­tial sce­nar­ios, all with very dif­fer­ent in­vest­ment con­se­quences.

The first is the con­sen­sus sce­nario; the one opin­ion polls in­di­cate is the most likely. Specif­i­cally, House, the Se­nate is more or less evenly di­vided, and the GOP keeps con­trol of the House. This is the sce­nario that in­vestors have gen­er­ally seen as the most be­nign— although one may ques­tion whether this sce­nario would re­ally be all roses for fi­nan­cial mar­kets. With the scan­dals sur­round­ing the Clin­ton Foun­da­tion and the un­ortho­dox email poli­cies fol­lowed by Clin­ton and her staff, the GOP will likely look at any­thing short of a Clin­ton land­slide as an open door to sub­poe­nas, im­peach­ment pro­ceed­ings, etc. The up­shot should be more paral­y­sis on Capi­tol Hill, and a Fed­eral Re­serve that would likely con­tinue to be the only “ac­tively func­tion­ing” arm of govern­ment. In turn, this would likely mean a range-trad­ing US dol­lar (be­cause the Fed would prob­a­bly hike less than cur­rently ex­pected), medi­ocre US growth, and con­tin­ued out­per­for­mance from emerg­ing mar­kets (as the po­lit­i­cal risk in EMs con­tin­ues to be low rel­a­tive to DMs). In short, more of what we have ex­pe­ri­enced in 2016…

The

land­slide

Hil­lary Clin­ton wins the White

Clin­ton

sec­ond sce­nario is the

sce­nario: GOP vot­ers stay home and Democrats turn out in droves (though im­por­tantly, early vot­ing seems to in­di­cate the op­po­site, with a wor­ry­ingly low turnout for Clin­ton among Mil­len­ni­als and African- Amer­i­cans), with the Democrats win­ning the White House, the Se­nate and the House. In such a sce­nario, bond yields would likely rise on the prom­ise of large fu­ture bud­get deficits, the US dol­lar would most likely weaken on the same ex­pec­ta­tion, while sta­ble US growth stocks (es­pe­cially phar­ma­ceu­ti­cals) would get crushed on the back of ris­ing bond yields and the threat of higher taxes and in­creased reg­u­la­tion. In this sce­nario, any US eq­uity mar­ket re­lief rally should most likely be faded. The third sce­nario is the pos­si­bil­ity that

emerges as a clear win­ner, ei­ther be­cause too many states are too close to call in a re­peat of 2000 (both can­di­dates are al­ready de­ploy­ing armies of lawyers), or be­cause third party can­di­dates win New Mex­ico (Gary John­son) and/or Utah (Evan McMullin). That would leave both Clin­ton and Trump short of the re­quired 270 Elec­toral Col­lege votes and send the fi­nal de­ci­sion to the House of Rep­re­sen­ta­tives. One could ar­gue that such an out­come would prove that the sys­tem works, and that the Found­ing Fa­thers in their ge­nius had de­vised an id­iot-proof elec­toral mech­a­nism, as a vote by the House would open the door to some­one other than one of the two most loathed peo­ple in Amer­ica be­com­ing pres­i­dent!

Still, it is un­likely that the mar­kets’ ini­tial re­ac­tion to such an out­come would be pos­i­tive. In­stead, stocks and bond yields

nei­ther Clin­ton nor Don­ald Trump

would fall to­gether, while the US dol­lar would most likely rise (on the “risk-off” bid), along with the yen and pos­si­bly ster­ling (the pound re­mains deeply un­der­val­ued and, ar­guably, most of the bad news for ster­ling is al­ready out there). Fi­nally, the fourth sce­nario is that

— a pos­si­bil­ity that seems to us much more likely than the odds cur­rently be­ing given by most po­lit­i­cal ex­perts. This view is based on our own re­cent ex­pe­ri­ences: in al­most ev­ery vote in re­cent years, na­tivist/na­tion­al­ist par­ties or causes have tended ei­ther to do bet­ter, or to do much bet­ter, than po­lit­i­cal polls pre­dicted. The lat­est ex­am­ple of that was the Brexit vote, but be­fore that one can look at the re­sults of the Na­tional Front in France, or UKIP in Bri­tain, or the Free­dom Party in Hol­land, or the True Finns etc… Sim­ply put, the over­whelm­ing po­lit­i­cal cor­rect­ness of our days means that, in most coun­tries, there ex­ists a “shy voter” syn­drome whereby a sig­nif­i­cant por­tion of na­tion­al­ist vot­ers are re­luc­tant to re­veal their pref­er­ence to poll­sters.

Of course, one may ar­gue that no such shy­ness ex­ists in Amer­ica, where peo­ple are more prone to flag-wav­ing while shout­ing their coun­try’s name than any­where else on earth.

On this last sce­nario, we have had in­tense de­bate in­ter­nally and ex­ter­nally over the likely im­me­di­ate fi­nan­cial im­pact of a Trump

Trump wins

Don­ald

vic­tory.

How­ever re­cent mar­ket move­ments would seem to in­di­cate that we should, at best, ex­pect the same type of en­vi­ron­ment that pre­vailed in the UK im­me­di­ately af­ter the Brexit vote: a col­lapse in the US dol­lar (over the past month the DXY has had a 1:1 neg­a­tive cor­re­la­tion with Trump’s poll num­bers), com­bined with a big pull­back in stocks (as Trump’s num­bers have edged back up, eq­uity mar­kets have headed south), along with lower bond yields (would the Fed re­ally raise rates in De­cem­ber if Trump wins?) and a higher gold price. The ques­tion would then be whether such a pull­back in the US dol­lar and in global eq­ui­ties rep­re­sented a buy­ing op­por­tu­nity for both and a sell­ing op­por­tu­nity in bonds, or whether it was the start of a much nas­tier in­vest­ment en­vi­ron­ment.

Putting it all to­gether, it seems un­likely that the mar­kets will act pre-emp­tively on any of the above sce­nar­ios; and nei­ther should our clients. In­stead, it prob­a­bly makes sense to wait out the im­me­di­ate af­ter­math of the vote in the few as­set classes that should still per­form re­spectably al­most re­gard­less of the out­come. As we see it, these are UK gilts de­nom­i­nated in ster­ling, Ja­panese govern­ment bonds de­nom­i­nated in yen, and gold. At this stage these seem to of­fer the best risk-re­turn pro­file go­ing into this highly im­por­tant, but most un­cer­tain, elec­tion.

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