Right on the elec­tion, dead wrong on the mar­ket re­ac­tion

Three pos­si­ble rea­sons for why stocks soared

Waterloo Region Record - - Business - JAMES MACK­IN­TOSH

I had a well-worked-out fore­cast for what would hap­pen to stocks af­ter the midterm elec­tions. It was smart, log­i­cal, and 100% wrong. Quite why is an in­ter­est­ing ques­tion, and shows how hard it is to pre­dict mar­kets even when events go ex­actly as pre­dicted.

My flawed pre­dic­tion was that U.S. stocks would fall in the event of the widely ex­pected Demo­crat win of the House and Repub­li­can re­ten­tion of the Se­nate. The ar­gu­ment started with the prob­a­bil­i­ties. Bets on the Iowa Elec­tronic Mar­kets be­fore polling day had the split Con­gress at about 60%, a roughly 30% chance of the GOP keep­ing House and Se­nate and a “blue wave” giv­ing the Dems con­trol of both at just 10%.

Con­tin­ued Repub­li­can con­trol would have led to hopes of more stock-mar­ket-friendly tax cuts, and the prob­a­bil­ity was high enough that it was an ob­vi­ous trade to profit if that one-inthree chance hap­pened. It didn’t, so I ex­pected those bets would be un­wound, lead­ing the mar­ket to fall.

There are three de­cent rea­sons why I was wrong, and the rea­son the stock mar­ket soared af­ter the elec­tion could be down to any one of them, or parts of all of them.

First, I was look­ing at the wrong mar­ket. Rather than

stocks, the fo­cus should have been on the dol­lar and Trea­sury mar­kets, which fol­lowed ex­actly the play­book I’d set out. When Fox News called the House for the Democrats at 9.30 p.m. the dol­lar tum­bled, Trea­sury yields jumped and in­vestors un­wound their bets on yet more deficit-bust­ing tax cuts. Stock fu­tures were ba­si­cally un­changed for hours af­ter­ward.

Sec­ond, in­vestor psy­chol­ogy. Bond in­vestors of­ten ac­cuse share­hold­ers of be­ing driven by emo­tions, and per­haps there was an el­e­ment of emo­tion at work. Alan Ruskin, macro strate­gist at Deutsche Bank, points out that much of the anal­y­sis be­ing cir­cu­lated by Wall Street and re­ported by the me­dia showed that pre­vi­ous midterm elec­tions were typ­i­cally

fol­lowed by a stock rally to the end of the year. This past record might have given in­vestors — shaken by the Oc­to­ber sell­off — con­fi­dence to pile back into the mar­ket af­ter the elec­tion.

Equally, in­vestors might have just been ner­vous about the elec­tion out­come and hold­ing on to cash to avoid the un­cer­tainty. With the re­sult out, they were ready to get back into stocks, push­ing up prices. Ei­ther way, U.S. stocks had a fab­u­lous day on Wed­nes­day.

The fact that Eu­ro­pean stock fu­tures did ba­si­cally noth­ing af­ter the elec­tion un­til the eq­uity mar­ket opened, when stocks soared — and that this co­in­cided ex­actly with U.S. stock fu­tures tak­ing off — sup­ports the idea

that ner­vous in­vestors had held off buy­ing un­til af­ter the elec­tion. Only when the fu­tures-mar­ket spec­u­la­tors saw real money go­ing to work in stocks did they join in.

The third ex­pla­na­tion is the least likely. Per­haps in­vestors were so wor­ried about the im­pli­ca­tions of a blue wave for stock prices that they had hedged their port­fo­lio to min­i­mize losses. When the wave turned out smaller than they feared, they no longer needed the pro­tec­tion, so could buy back in. The trou­ble with this ar­gu­ment is the tim­ing: Why the big dol­lar and bond moves but lit­tle ac­tion in eq­ui­ties un­til Eu­ro­pean stocks opened?

A fi­nal sug­ges­tion is that in­vestors thought Mr. Trump is now more likely to strike a deal on trade with China to avoid more tar­iffs, in or­der to bol­ster his po­si­tion be­fore the 2020 elec­tion. Leave aside the ques­tion­able logic here; the fall in the dol­lar would fit with this story (tar­iffs push up the dol­lar), but im­proved hopes on trade ought to help Chi­nese stocks, and didn’t, much. It is true that China’s mar­ket is much less con­nected to global stocks thanks to its do­mes­tic dom­i­nance and cap­i­tal con­trols, but given the mar­ket was open, it was odd that stocks rose only 0.4% as the yuan rose against the dol­lar, and then stocks gave back all their gains and more even as the yuan kept ris­ing.

I’m in­clined to think both the first two ex­pla­na­tions are right, and the ob­vi­ous les­son is not to have too much con­fi­dence in one’s pre­dic­tions of how the mar­ket will re­spond.

Even if you’re sure what will hap­pen in some event, stocks might do some­thing quite dif­fer­ent. Moves in other as­sets can have big knock-on ef­fects to the stock mar­ket. And an­tic­i­pat­ing how other in­vestors will re­act — in­vestors who are try­ing to pre­dict each other’s re­ac­tions too — is typ­i­cally more im­por­tant in the short run than the true fun­da­men­tal ef­fects of what­ever ac­tu­ally hap­pens.

The ba­sic ad­vice is long­stand­ing: Re­gard any short-term trade as no more than a punt, and ex­pect to lose your stake.


Traders re­act to mar­ket move­ments on Wed­nes­day on the floor of the New York Stock Ex­change.

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