Political and Capital Markets (Nov. 2)

Mike & Co.,

Millions of Americans have been waiting for this, argued and agreed with family and friends, made up their minds, and are ready, at long last, for the outcome — of Game 7, the Cubs representing the Secretary’s original home state and Cleveland, representing a key battleground state.   I can tell you what the score of the game will be before the first pitch and am willing to bet.

Today, in its last announcement before the election, the Fed expressed  optimism regarding continued economic recovery while hinting at a rate hike in December.

With under a week to go to the election, capital markets are not necessarily responding to the Fed but are instead bracing for the possibility of a Trump victory as polls show the race tightening.  What the markets are saying, below.

Best,

Dana

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Fed Interest Rates

Today, the Fed released its last announcement before the election, following its two-day meeting on interest rate policy and the current state of the economy.   The Fed again deferred a rate increase but did signal that a hike is probably next.

Interest rates had been lagging Fed target rates all year, increasingly a concern for Yellen and other Fed officials.  The continuing improvements in job growth and signs of modest inflation, along with better than expected GDP growth in the third quarter, point to an interest rate hike in December.

These improvements are promising, but some have noticed with concern that the tightening of the election has increased volatility in the market.  Following the FBI announcement that it was looking at additional emails, many battleground state polls but the difference between the candidates inside the margin of error.

The Fed does not base its decisions on ephemeral indicators such as daily stock prices and political market bets.   As Yellen has repeatedly indicated, the Fed’s focus is on longer-term indicators such as GDP growth, unemployment and inflation, which will remain largely unaltered by these fluctuations.  While the increased chance of a Trump victory could unsettle the market, it carries sway with the Fed’s long term plans.

Political Markets

In early October, the Real Clear Politics poll average showed a 7-point lead for HRC as late as October 17.   The RCP reports Clinton’s lead at 1.7 points today.

A Moody’s Analytics model that has predicted the last nine presidential elections correctly forecast a 332-206 electoral college victory for HRC, with 95 percent confidence that she will receive at least 270 votes.  The model, which relies on state by state economic indicators and political history, predicts that HRC will ride Pres. Obama’s increasing popularity to the White House. Political betting markets have historically been extremely accurate.

But the political markets have been moving:

• the Iowa Electronic Markets, the most established online exchange which allows traders to buy and sell futures in the likelihood of an event’s occurrence, saw HRC’s odds of victory fall from 89.5% last week, to 64.1 percent yesterday
• HRC’s chances fell 11 percent to 73 percent on Betfair, where people bet on the outcome of the Electoral College

Capital Markets 

A majority of forecasters predict stocks will do much better under a Clinton administration than a Trump one, largely because of the latter’s populist rhetoric against free trade and his ambiguous foreign policy plans.  A new report by the Brookings Institute shows that the stock market would preform 11 percent better under a Clinton administration than a Trump one.  It also predicts a sharp fall in stock prices — in a magnitude similar to that experienced in the wake of Brexit –should Trump pull off an upset. It therefore comes as no surprise that stocks have taken sustained hits over the last week as polls have tightened.

• DJIA has fallen 1.5 percent while the S&P 500 has fallen almost two points in the last 6 days following the FBI announcement
• the so called “fear index”, or the VIX market has also seen troubling gains. The VIX tracks volatility in the market, and reflects expected market risk in the near future. Since the FBI’s announcement and Trump’s gains in the polls, the VIX has risen by over 40 percent, the highest it has been since early September – the last time the election was this close
• the dollar has fallen against the Euro, Yen and Swiss Frac as demand for U.S. treasuries has decreased
• the tightening of the race has also been reflected in the international market, with the Mexican Peso falling 1% against the dollar in the last few days, following gains in early October
• safer assets such as gold have rallied to month long peaks; after the first debate, when HRC was declared the winner by almost all onlookers, gold valuation took a significant hit

These indicators have all pointed to a market that is deeply afraid of a Trump presidency, and a market that is concerned with an increasingly narrow gap between the candidates.  And despite strong gains in growth and employment reported in the last few weeks, the S&P 500 finished 2.2 percent lower November 1 than it was August 1.

Campaign Implications  |  The above trends indicate that capital markets would significantly prefer a Clinton presidency, but are try to price-in or foreshadow a Trump win.  It could also be that this year is an anomaly — imagine that — and the markets are merely hedging.  Informing the savvy market prospectives on the election is awareness that — Trump’s boasts about his businessman background notwithstanding — Wall Street stocks would preform 11 percent better under an HRC presidency.