A great deal of debate has gone on regarding the trustworthiness of the two major candidates in this year’s presidential election. Much has been made of the fact that Democratic nominee Hillary Clinton and Republican nominee Donald Trump have the highest unfavorable ratings and percentage of people who view them as untrustworthy in modern election history. But given the populist revolts in both parties and where that has brought both candidates — from a financial industry perspective — there may be more worry about whether candidates are telling the truth than whether they are lying.
First of all, the candidates have veered off-course of some traditional expectations. Trump has left the GOP reservation on issues of trade, defense posture, tax policy (carried interest) and government spending. Clinton heads into the general election in a different posture than where she began, thanks to the popularity of Socialist candidate Bernie Sanders (I-VT) pulling her leftward.
“I won’t say Republican/Democrat because Trump by all metrics is not a Republican in terms of his policies,” says Brad Bailey, research director with Celent. “It is also important to note, some of the things he has said — and how else do we judge someone other than by what he said — are radical. He’s brought things to the table that would impact the economy, the markets — whether you talk about fixed income, equities or forex. He’s talked about the debt and re-evaluation of the debt.”
While Trump has stepped back from some of his comments suggesting that debt and the full faith of U.S. Treasury obligations can be negotiated, his business track record regarding the use of bankruptcy codes and comments regarding renegotiating of debt still has some business folks worried.
“The United States has never reneged on debt,” Bailey says. “Even after wars, [debts] have been made whole. When you look at economies that regularly renege on their debt, you don’t want to be in those countries,” he says.
“A lot of international investors’ pension funds don’t want to own Treasuries if Trump is the President,” says Lawrence McDonald, head of global Macro Strategy for ACG Analytic and founder of the Bear Traps Report. “But to this point they don’t appear to be taking Trump seriously and it is hard to stay away from the U.S. market because of the yield advantage. The 10-year Treasury is yielding substantially more than all of the developed markets in the world.”
On the other hand, Bailey notes, “[Clinton] has moved to the left, she supports a strong regulatory environment, [she appears to be] rethinking many of the deregulations under her husband’s term under [Treasury Secretary Robert] Rubin. [Some say] she would move to the center but [she] has a history of being pretty liberal, and that gives pause to a lot of people.”
So while the consensus of analysts is that the market doesn’t like Trump because of the uncertainty he represents, Clinton offers uncertainty as well. McDonald says Clinton has flip-flopped on the Trans Pacific Partnership (TPP) as well as other issues, but expects her to move back to core positions. “My main premise is that she is going to move way to the right if she wins,” he says.
“I know that from high-ranking donors who are very close to her.”
“Some people will look at it as her husband came in and moved to the center and was a great President but the fact is Hillary, when she was First Lady, tried to get universal healthcare through,” Bailey says, while adding, “She has proven to be a quite pragmatic politician. You have to look at the choices — Trump doesn’t give a lot of confidence but maybe that is what we need, a new day in America.”
“There was a thought that [Trump] would change in the general election. It actually got worse once he became the nominee — that has given people concern,” Bailey says. “There are people I know who would never vote for a Democrat who are either not voting or considering voting for Clinton. That said, I know people in the financial world that [see] Trump as a businessman: He’s been there, he’s experienced, he’s dealt with real world negotiations, he understands the challenges, he understands issues around tax and investments, and they see that as a positive and are willing to put aside a lot of the noise about what he says as a show.”
If analysts are somewhat unsure of the candidates, the electorate also offers some uncertainty.
The Brexit effect
“There is something about this election. It is the type of thing where people don’t tell the truth about what they are thinking,” Bailey says. “I don’t know what is going to happen, things are pointing toward a big win for Clinton, but Trump, prior to becoming the nominee, was finding support among very wide and varied types of people.”
And those people are mad, not just here but all over as exemplified by the Brexit vote. They are mad at the establishment and in this election the establishment is Clinton.
“Some of Brexit was pure anti-intellectualism but on the other side I get it,” Bailey says. “But it is one thing not to be a professor and another thing to have someone like Trump, who doesn’t read books, doesn’t have a historical context [and] doesn’t seem to have a nuanced understanding of very complicated situations.”
This is in line with the Brexit movement, however. “There is something going on globally as far as trade,” McDonald said following the German election in September that saw social Democrats lose many seats. “It is anti-trade, anti-immigration, anti-global trade. German Chancellor Angela Merkel lost seats in her home city. It is definitely something that is a once-in-a-(generation) movement. It is like a freight train running downhill and it is very supportive of Trump. If Trump just keeps his nose clean, he wins in a landslide.”
But McDonald and others see the market expecting a Clinton victory even though we spoke to them in early September after Trump had moved within the margin of error in most polls.
“The key to investing around politics is meticulously measuring what is priced in,” McDonald says. “As far as I can tell, the market is 80% priced in for a Hillary victory. The Hillary trade is priced in; the risk/reward on the Trump trade is very attractive because the market is not ready for it.”
Larry Tabb, CEO and founder of the TABB Group agrees. “Absolutely the market is pricing in a Hillary victory. Volatility is so low; you have to take its pulse to see if it is alive.”
In fact, the biggest indicator for the viability of a Trump victory, according to many analysts, is a rise in volatility.
“Even though he improved in the polls, I don’t think the market has changed that much,” McDonald says. “For the market to start taking him seriously, he has to get up five to 10 points. The reason is that he has been up at [these levels] four or five times and each time Hillary reverses it on him. He has never clearly taken the lead. Every time he gets up here he [messes] up something, attacks somebody’s mother and is back down eight points in the polls.”
If the market believed Trump had a chance at this point, McDonald says Treasuries would be selling off.
What convinces McDonald of Trump’s chances are four pieces of evidence: “You have the German vote in March, Brexit, the German vote in September and Trump beating 16 accomplished Republican candidates. Something is going on here. I am not sitting around pretending something is not,” he says. “Either Trump wins, which I think he will — but even if he doesn’t the chances of Trump winning are going to go from 25% to 75% back to zero. Trump doesn’t have to win; if he goes from a 25% chance of winning to a 75% chance and back to zero, there is a huge trade there.”
The Trump trade
McDonald sees several sectors benefiting from a Trump victory. “One would be healthcare: the biotechs and big Pharma would be crushed with [Clinton’s proposal] to create an open committee that would review drug pricing. Just look at the [iShares Nasdaq Biotechnology Index (IBB)]; it is down 15% year-to-date and the S&Ps are up 8% — so you are talking 23% underperformance to the S&P“ (see “Trump play,” below).
“The more conservative way to play it is the big Pharma ETFs. That is a sector that is pricing in a Hillary victory. If Trump starts to pull ahead, that sector is going to reverse big time,” he says. “Coal is a big Trump winner. The other thing is the yield curve. If the election swings toward Trump, Treasuries are going to underperform because international investors that own Treasuries are very uncomfortable buying Treasuries if Trump is President. Selling bonds is another trade that benefits from a Trump surge in the polls.”
Matt Weller, senior market analyst for Faraday Investment Research, says, “Historically, on a long-term basis the U.S. dollar tends to strengthen during Democratic presidencies and weaken during Republican regimes. I think of the increasing probability of a Trump presidency might have contributed to the dollar weakness we saw [in the middle of September].”
“If we see a month before the election that the gap closes to basically a coin flip that will introduce a massive element of uncertainty and will lead to U.S. dollar weakness and U.S. stock [weakness] and cause businesses to hold off on investing and hiring, he adds.”
While proponents of Trump often look at undocumented immigration as a negative, it creates a lot of economic activity, according to Tabb. “Trump’s proposals would be very problematic to business,” Tabb says. “Kicking out millions of immigrants — these people get paid, they pay for services, they buy products, they contribute to the dollars spent in the United States. Getting rid of them is probably a net negative, especially with an unemployment rate under 5%. Who is going to end up filling those jobs?
“Making it harder to visit the United States is problematic for a lot of businesses as well,” Tabb adds. “He also talked about reducing the number of visas issued. There have been studies showing that a lot of the entrepreneurs starting U.S. companies are actually immigrants, so making it harder to have student visas, making it harder for them to stay, making it harder for them to immigrate — those companies will be started elsewhere and that is not a good thing for our long-term competiveness.”
According to McDonald, the big thing is the anti-globalization trade. “The countries that have the largest percentage of GDP in exports, like South Korea and Mexico, are the countries that are going to have the largest problem with Trump. If you look at global trade, it is already in the third year of decline and Trump is a protectionist. The market will probably overdo it but the global trade crowd is going to suffer.”
Speaking of Trump’s immigration policy, Bailey jokes, “If you are going to build a big concrete wall you should look at cement companies and construction companies, and if you are going to get rid of illegal immigrants you should look at automated machines to pick crops.”
But beyond the wall, infrastructure stands to gain in a Trump victory. “Next year, if Trump wins you are going to have a big risk-off and then a big risk-on,” McDonald says. “The risk-off will be the uncertainty of Trump and the risk on is going to be: ‘OK, the Fed is going to be more accommodative and you are going to have more stimuli.’ That will help the recovery.”
“He is going to get a lot more done than Hillary. He is going to get tax reform done, he is going to be able to get tax cuts, he will get repatriation of money from overseas. He is going to be able to work with Congress a lot better than Hillary,” McDonald says. “Although he is not well-liked, he is definitely going to have enough support to pass some bills, especially because he agrees with the House plan on tax reform and he is for tax cuts.”
If there is a sure-thing trade this election, it is in infrastructure stocks, according to McDonald, who says infrastructure ETFs are outperforming the S&Ps by as much as 400 basis points, and they stand to do well whoever is elected. “If Hillary wins she will pass legislation that will improve U.S. roads and bridges and infrastructure. You are talking $200 to $250 billion in spending,” he says. “U.S. GDP is only growing at 2% ($18 trillion) and 1% of that is $180 billion — $250 billion would be more than 1% of GDP on infrastructure building (see “Win-win,” below).”
While Congress probably would not pass all of what Clinton asks for, some stimulus is likely. “We need some type of fiscal stimulus from Trump or Hillary,” McDonald says. “Obama has been toxic with Congress. He has gone around them so many times. He couldn’t even get emergency funding for Zika passed. Hillary is going to be able to pass legislation much better than Obama. The beginning of any administration, Congress typically plays ball with the President. President Obama ran four consecutive trillion-dollar deficits — a lot of that had to do with the financial crisis — but some of it had to do with the fact that when you come into office you have some coattails.”
The bottom line is that whoever wins, expect more fiscal stimulus.
Trade & taxes
From a business and markets point-of-view, both candidates support policies that could harm industry. For Trump it is his anti-trade, protectionist stand; and for Clinton it is her embrace of stronger regulations, including a financial transaction tax (FTT).
“The FTT would be a disaster in so many dimensions. If you are thinking along those lines you have to think about the capital markets robustly. You don’t want to do anything that impinges on that,” says Bailey.
While the Democratic Party platform called for a financial transaction tax, Clinton has offered a lighter version referred to as cancellation tax (see “Open (Political) Season on Traders,” page 23).
“[What] we will see from Clinton is a sort of high-frequency trading cancellation tax. I am not necessarily sure it is going to happen, it is certainly part of her platform,” Tabb says. “The question is when it comes down to it, will market-based taxes be effective? Robert Reich [Secretary of Labor under President Bill Clinton] is trying to promote a full transaction tax. That is pretty doubtful. What Hillary is taking about is a high-frequency trading cancellation tax, which depending on how it is levied will wind up impacting the ability to provide capital to equity markets.”
So, despite the seeming compromise, Clinton’s proposal would likely harm liquidity and not hit its spoofing target.
“There are market makers who quote a lot and that is good activity — they are competing to determine the right price. Then you have people who are trying to pick off people when their quotes aren’t fully reflective of the current price. Those are the people you want to dissuade,” Tabb says. “Sometimes market makers are using high-speed technology to take liquidity but usually that is to reduce their risk. The problem is that their cancellation rates are actually low, so a cancellation tax actually creates the wrong incentives.”
One area of agreement is that both campaigns support ending the carried interest loophole for hedge funds. “That has a much more realistic chance of occurring; the HFT tax may occur but I don’t think it is the right solution,” Tabb says.
Trade is another area of agreement as far as both oppose the TPP, but Trump has also promised raising tariffs, fighting currency manipulation and tearing up trade deals.
“China has been the supplier of liquidity for the world. They are buying our Treasuries. The world has relied on China to make things and hence they have gotten a tremendous amount of money flowing to them. A major trade war with China would be painful to U.S. consumers and painful to China in how they have been funding themselves,” Bailey says. “We as Americans have benefited greatly from the free flow of capital and goods. If you are going to start renegotiating, making the world smaller to protect certain industries, there will be a drag on the overall economy.”
Tabb acknowledges that some trade deals like NAFTA have hurt certain sectors, but says it has been a net positive. “By and large it enabled us to buy goods at lower prices as well as export a number of higher value services. If you eliminate the trade deals it is probably a net negative for the economy,” Tabb says. “What are these guys doing with all of the U.S. dollars they get from selling products in the United States? They have to either buy financial products or convert that cash into local currencies and spend it.
If we are importing less, there [are far fewer] U.S. dollars to buy U.S. financial products.”
While some analysts question Trump’s ability to kill past trade deals, McDonald says there is a lot that can be done. “He can’t tear them up but executive orders give you a lot of leeway on some of these treaties. He can try and renegotiate them by using other weapons,” McDonald says. “If you look at the Nixon Administration, he was able, through executive orders, to do a number of things on trade without passing it through Congress.”
The bottom line from a markets point-of-view is that the potential of a trade war would do a lot of harm.
“If [Trump] pulls ahead in the polls, the market will fear a global trade problem [and] will probably overshoot it,” McDonald says.
“It would hurt the stock market because 40% of U.S. profits are overseas now. It would hurt [exporting] countries.”
Who will win
The consensus among analysts is that the market is still pricing in a Clinton win, though any spike in volatility may be an acknowledgment that Trump’s chances are improving.
“If there is some major dislocation in markets that would probably be good for Trump,” Bailey says. “There is nothing markets like better — especially fixed income and equity investors — than a sense of knowing. They don’t want surprises.”
Clinton offers market participants more comfort. “Clinton was a Senator in New York; she knows the financial community, she certainly has done a lot with the banks,” Tabb says.
He acknowledges that some policies may not favor markets but adds that the market discounts that as her placating Sanders supporters.
“The markets by far would prefer a Clinton presidency,” Weller says. “Markets see that a non-politician like Trump could introduce a massive element of uncertainty, so the close ties that Clinton has with Wall Street and an extension of a status quo regime are what markets are hoping for; that is why we saw dollar strength earlier.”
“A Trump presidency would be a bigger change. His tax plan, if enacted, would lead to greater deficit,” Weller says. “There are both short- and long-term effects of deficits.
In the short-term, it puts more money in the economy and could serve as a boost to economic activity but in the long run, and we are starting to see some of the other developed nations dealing with this, additional deficits get risky from a sustainability or credit quality perspective.”
McDonald agrees that Trump would create larger deficits that could at least initially stimulate the economy, after the shock of a Trump victory wears off. The market will overreact to Trump; you will see a vicious move and then the market will correct and normalize. Trump will be a little like Reagan for the market. He will create a lot of stimulus; you will see a huge move up in the market after a big move down.”
Cynically, Bailey adds, “Politicians tend to lie. It really is a shame that Clinton seems to default to lying and Trump will say anything, and some of the stuff he says can be concerning for someone who [could become] the most powerful person on the planet.”
McDonald is convinced that even if Trump does not win, a greater likelihood of a Trump victory will cause a big move in certain markets prior to the election, which will be good for traders positioned for it.
Is gridlock the ideal electoral outcome?
By David Kedmey
Let’s pull back from this year’s mud-slinging, hair-pulling presidential contest to consider whether any election, ever, had the power to move markets.
Democratic presidents, at first glance, appear to have a lock on growth (see “Trending blue,” Below). Every year that the Democrats held the White House, the S&P 500 averaged a return of 12.3%. Under Republican leadership, the S&P’s performance sagged to an average of 5.7% (see “Trading the election,” below).
Of course, averages mask a wide range of outcomes. Both parties have presided over some wild swings over the years. Looking at the most common swings — between the 85th and 15th percentiles — the Democrats still come out on top. S&P returns ranged from a high of 26.3% and a low of -2.1% within this percentile range. Republicans nearly matched the upside at 25.9%, but delivered a much more alarming downside at -12.5%.
So, if markets truly flourish under the benign leadership of Democrats, one might reasonably expect the heartiest growth spurts to occur when they also gained control of Congress. Unfortunately, that’s when the markets appear to move in the wrong direction. A Democratic sweep of the White House and Congress coincided with an average return of 7%. That growth rate nearly doubled, however, when Republicans regained control of the Senate and squared off against a Democratic rival in the White House, averaging 13.9% returns during those glorious days of gridlock.
The CXO Advisory Group put together an interesting study where they looked at all potential combinations of government control: The party of the president, House and Senate from 1950 through 2015. The strongest return for the S&P 500 (16.5%) occurred with a Democrat in the White House and the GOP in control of the Senate, which existed for eight years. The next combination producing the highest returns (15.9%) was with a Democratic president and Republican House (11 years). The study also showed strong returns (15.3%) when the GOP controlled Congress (12 years) and when the GOP controlled the Senate, 14.4% (20 years). The paper suggests that the strongest market factor may be Republican control of the Senate. The worst combination, 2.6%, was with a Republican president and Republican House.
Conflicting numbers suggest that neither party has a surefire recipe for growth. The market chugs along, gaining and losing steam with only a tenuous connection to electoral outcomes. And while weak correlations can draw strong partisan emotions, another model offers a cautionary tale: UFO sightings nearly doubled when Democrats held the White House (see “Lies, damn lies and statistics,” below). And who’s to say they didn’t cause that as well? The truth is out there