The Trump Effect on Markets: A Financial (not a Political) Analysis!
There are few events that catch markets by complete surprise but the decision by
As the election results came out on Tuesday night, the immediate market reaction was dire, with Dow futures dropping almost 800 points, triggering circuit breakers. By Wednesday morning, though, the panic seemed to have subsided and the market effect in the two days since the election have been not just benign, but positive. I know that it is early and that much can happen in the next few weeks to spook markets again, but as things stand now, here is what we see. Rates on US treasuries have risen sharply, with interpretations varying depending upon your election priors, with those negatively inclined to Trump viewing the rise as a sign that foreign buyers are pulling out the market, leery of his comments about and those positively inclined arguing that the rise reflects expectations of higher growth in the future. The dollar has held its own against other currencies and the fear indices (gold and the VIX) have fallen since Tuesday, with the VIX dropping dramatically. US stocks have risen in the two days since the election, with small cap stocks in Russel 2000 rising more than the large cap stocks. If you are puzzled by the NASDAQ's inability to join the rally, you can see why when you look at the returns across the S&P sectors:
Last 5 days | Last 3 months | YTD (2016) | |
---|---|---|---|
Consumer Discretionary | 2.46% | -2.57% | 1.05% |
Consumer Staples | -0.88% | -4.97% | 2.95% |
Energy | 3.80% | 3.50% | 16.79% |
Financial Services | 6.48% | 7.46% | 6.38% |
Financials | 6.71% | 6.70% | 7.77% |
Health Care | 6.20% | -5.36% | -1.74% |
Industrials | 5.59% | 2.23% | 12.58% |
Materials | 4.39% | -0.94% | 11.15% |
Real Estate | 0.40% | -12.21% | -3.83% |
Technology | 1.37% | 0.45% | 10.55% |
Utilities | -1.17% | -6.59% | 9.43% |
S&P 500 | 3.11% | -0.85% | 5.84% |
The stock market rise in the last few days has been uneven with consumer staples, utility, technology and real estate stocks (ironically) lagging and financial firms, health care and industrials doing well. Though it is dangerous to try to create full-blown stories based on stock market behavior over a few days, it seems likely that the rally in financials and pharmaceuticals can be traced as much to expectations about what Trump has said he will do (repeal Obamacare, for instance) as to relief that some of the regulations/restrictions that Clinton had proposed (on pharmaceutical pricing and more constraints on banks) would not longer be on the table. The decline in utilities can be attributed to rising interest rates but the swoon in tech stocks bears watching, since it could be an indication that tech companies, who strongly backed Clinton, may face headwinds in a Trump administration.
I know the perils of assuming that campaign promises and rhetoric will become policy, but broadly speaking, you can outline the possible consequence for companies of Trump's proposed policy changes. The biggest and potentially most negative effect would come from his trade policies, where protectionist policies can and will draw protectionist responses from other countries, putting global trade and growth at risk. Trump has been ambivalent about both the Federal Reserve's interest rate policies and financial markets, arguing that the Fed has played politics with interest rates and that financial markets are in bubble territory. It will be interesting to see whether the FOMC, when it meets in December, takes into account the election results, in making its widely telegraphed decision to raise rates (at least the ones that it controls). Trump has proposed major changes to both corporate and individual tax rates, and if Congress goes along even part way, you can expect to see a lower corporate tax rate accompanied by inducements to bring the $2.5 trillion in trapped cash that US companies have in other markets.
There is also likely to be sector-specific fall out from other Trump policies, at least in contrast to what these sectors would have faced under a President Clinton. President Trump has prioritized repealing Obamacare and that will have direct consequences for companies in the health care sector, with some benefiting (pharmaceutical companies?) and some perhaps being hurt (insurance companies and hospital stocks?). President Trump's proposal to invest heavily in the nation's infrastructure will benefit the construction, engineering and raw material firms that will construct that infrastructure but he may run into both budgetary constraints (with his tax proposals) and political headwinds (from conservatives in Congress). Finally, President Trump has promise to reduce regulation on business and put in more business-friendly regulators on the regulatory bodies and that will be viewed as good news by banks and fossil-fuel firms that were facing the most onerous of these regulations. The Trump proposals to preserve the entitlement programs, lower taxes and increase infrastructure spending are potentially at war with each other and budget constraints, but that does not mean that significant parts of each one will not become law.
In evaluating these possibilities, I am cognizant of the checks and balances that characterize the US system. Unlike parliamentary systems, where a new government can quickly rewrite laws and replace old policies, the framers of the US constitution put in a system where power is shared by the executive, the legislature and the courts, making change difficult. Even with Republicans controlling the executive and legislative branches, I am sure that Trump supporters will be frustrated by how slowly things move through the mill and how difficult it is to convert proposals to policies and Trump detractors will learn to love the same filibusters, congressional slowdowns and legal roadblocks that they have inveighed against over the last eight years.
It is easy to get caught up in the crisis of the moment but there are general lessons that I draw from Brexit the Trump election that I hope to use in molding my investment strategies.
- Markets are not just counting machines: One of the oft-touted statements about markets is that they are counting machines, prone to mistakes but not to bias. If nothing else, the way markets behaved in the lead-up to
Brexitthe election is evidence that markets collectively can suffer from many of the biases that individual investors are exposed to. For most of the last few months, theBritish PoundMexican Peso operated as a quasi bet onBrexitthe US presidential election, rising as optimism thatRemainClinton would prevail rose and falling as theLeaveTrump campaign looked like it was succeeding. There was a more direct bet that you would make onBrexitTrump in a gamblers' market, where odds were constantly updated and probabilities could be computed from these odds. SinceBrexitthe US election was also one of the most highly polled in history, you would expect the gambling to be closely tied to the polling numbers, right? The graph below illustrates the divide.
While the odds in the Betfair did move with the polls, the odds of
the Leave campTrump winning never exceeded 40% in the betting market, even asthe Leave camp acquired a small lead in the weeks leading up to the votethe polls got closer in mid-September and in the last week before the election. In fact, the betting odds were so sticky that they did not shift tothe Leave side until almost a third of the votes had been countedTrump until late on Tuesday night. So, why were markets so consistently wrong on this vote? One reason, as this story notes, is that the big bets in these markets were being made byLondon-basedbigger investors tilting the odds in favor ofRemainClinton. It is possible that these investors so wantedthe Remain voteClinton to win that they were guilty of confirmation bias (looking for pieces of data or opinion that backed their view). In short,BrexitTrump reminds us that markets are weighted, biased counting machines, where big investors with biases can cause prices to deviate from fair value for extended periods. - No one listens to the experts (and deservedly so): I have
neveronly once before seen an event where the experts were all so collectively wrong in their predictions and so completely ignored by the public. Economists, foreign policy experts andcentral banksopinion leaders all inveighed againstexiting the EUTrump, arguing thatiselecting him would be catastrophic, and their warnings fell on deaf years, as voters tuned them out. As someone who cringes when called a valuation expert, and finds some of these experts to be insufferably pompous, I can see why experts have lost their cache. First, in almost every field , expertise has become narrower and more specialized than ever before, leading to prognosticators who are incapable of seeing the big picture. Second, while experts have always had a mixed track record on forecasting, their mistakes now are not only more visible but also more public than ever before. Third, the mistakes experts make have become bigger and more common as the world has become more complex, partly because the interconnections between variables means there are far more uncontrollable elements than in the past. Drawing a parallel to the investment world, even as experts get more forums to be public, their prognostications, predictions and recommendations are getting far less respect than they used to, and deservedly so. Finally, it is time that we that are open about the fact that we are all biased and being smart or an expert does not immunize from bias. - Narrative beats numbers: One of the themes for this blog for the last few years has been the importance of stories in a world where numbers have become more plentiful. In the
Brexit debateUS presidential election, it seemed to me thatthe Leave sideTrump had the more compelling narrative (of a return to an an oldBritainAmerica that enough voters found appealing to help him win) and whilethe Remain sideClinton argued that this narrative was not plausible in today's world, its counter consisted mostly ofnumbers (the costs that Britain would face from Brexit)inveighing against Trump's character and temperament. Looking ahead to similarreferendumselections in otherEUcountries, I have a feeling that the same dynamic is going to play out, since few established politicians in anyEUcountry seem to want to make a full-throated defense ofbeing Europeans firstthe status quo. - Democracy can disappoint (you): The parallels between political and corporate governance are plentiful and
Brexitthis election has brought to the surface the age-old debate about the merits of direct democracy. While many, mostly on the winning side, celebrate the wisdom of crowds, there are an equal number on the losing side who bemoan the madness and prejudices of crowds. As someone who has argued strongly for corporate democracy and against entrenching the status quo, it would be inconsistent of me to find fault with theBritishAmerican public for voting forBrexitTrump. In a democracy, you will get outcomes you do not like and throwing a tantrum or threatening to move are not democratic responses. You may not like the outcome, but as an American political consultant said after his candidate lost an election, "the people have spoken... the bastards".
The End Game
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Thanks for the write up professor. Well thought-out posts like these, especially coming from industry professionals and academics, are a core of what makes WSO so great.
I think it's very interesting how you could literally take your Brexit response and change some phrases to relate to the election and really come out with the same parallels. Talking with colleagues, family, friends in the UK, it's almost impossible to not notice the same type of reactions as both Remain and Clinton were very much considered "sure bets" (which I completely thought as well). Interesting times indeed.
trump on markets and investment banks clients (Originally Posted: 11/09/2016)
how will trump winning affect the markets and global economy, and more specifically investment banks and their clients?
Thanks!
see here...
http://www.wallstreetoasis.com/forums/how-will-the-results-of-the-elect…
8% return on your money, no matter who wins the election says HSBC (Originally Posted: 11/02/2016)
HSBC has stated their belief that irregardless of whoever winning the upcoming election in a week's time, gold is expected to rise by 8%.
ps. what are you waiting for? Placing my order now!
Irregardless isn't a word.
they even test this on the SAT verbal, or used to at least
Haters gonna hate. Irregardless, keep using that word.
All the "Guns, Grub and Gold" people just woke up
just out of curiosity, in theory aren't guns the best "commodity" to own during very volatile times? they hold their value if you need to eventually sell, they'll keep the zombies away, and they have a bit more purchasing "power" than gold if shit hits the fan
thoughts?
I am by no means an expert, but I would think that you are right. Besides the monetary value, if shit really were to hit the fan, anything that allows you to exert power over somebody else or help kills zombies will be worth a lot.
Plata O Plomo ftw
Guns and oil.
Both serve immediate practical uses, and can be traded.
That logic does pair well with market sentiment of a pull back in 2017 or 2018. This is actually something I'm going to look into at work, if nothing else for shits-n-vomits.
What effect will politics have on the market in the fall? (Originally Posted: 09/06/2016)
Major indexes are near record highs and have been bullish for quite some time. Do you guys think there will be a correction within the next 2-3 months? Republican or Democrat this election seems to scare just about everyone.
Market seems to be favoring Clinton heavily now and appears priced in according to many of the economic pundits and powers that be. They seem to think that most of the anti-trade rhetoric is just pandering and that she'll be four more years of Obama which will be fine. Trump would be a complete catastrophe. Him + Brexit would provide some major doubt for world trade. Wouldn't want to see the aftermath.
I second what CanadianEnergyBanker says. I think that if Mr. Trump wins, he may likely (at least in the short term) cause the US stocks and dollar to plunge, as we saw in the case of Brexit. In a somewhat more extreme scenario, you may also see cases of skittish investors moving their assets abroad to new "safe havens" (wherever those may be) and other countries clamoring for the world to be less reliant on the US dollar.
This is ridiculous. Start focusing on yield and valuations.
whoever threw MS doesn't run money, this is spot on.
There's gonna be, like, sooooo much drama!
Cliinton will be, like: "Donald, you iz sh1t!" And Trump will be, like: "Hillary, you iz sh1tter!" And the mkt will be, like: "Whoa, dude!" And Janet Yellen will be, like: "Behave, you silly kids!"
And the end result will be that everything ends up roughly where it is today...
"A rising tide lifts all boats" - The market will muddle along with Clinton's policies as they have under Obama's, whereas Trump's policies will create economic value and growth. The market will remain relatively cautious until November.
Not a republican but this election isn't so clear cut at the moment. Trump is ahead in the CNN poll.
Johnson wins in a landslide and runs the DOW to 50,000. Take it to the bank.
You wouldn't happen to be Harry Dent III, would you?
If Trump wins I'm longing Mexican concrete
Underrated comment
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