This year’s presidential election has created an enormous amount of angst both politically and economically. Today, the day before the election, we look back at 9 days of S&P losses – the longest (but not the biggest) losing streak since 1980. Through Friday, in spite of very good earnings reports from companies, the S&P 500’s total decline has been 3.1%, and it has been relentless and deflating to investor psychology.
In our view, the primary reason for the sell-off – and this is not a political statement – seems to be the rising odds that Donald Trump could win the election. Our conclusion is based solely on the relationships we see between the trends. Remember, the earnings report (which will ultimately drive the market’s direction) are good, but the market is down.
On October 24, the day before the losing streak started, Nate Silver’s 538 Polls-Plus Model had Trump’s odds of winning the election at 16%. During the nine-day losing streak, those odds rose somewhat steadily to 36%.
If a 20 percentage point increase in Trump’s odds of winning generated a 3.1% decline in equities, then a simple back-of-the-envelope calculation suggests an actual Trump victory (which by definition means the odds increase by 64 percentage points – to 100% from 36%) could result in equities suddenly dropping about 10% below the Friday close. For the S&P 500, that would be about 1880, which would be the lowest level since February 2016.
If this happens (again, we are not making a political statement), we think this would be a great buying opportunity. It would be analogous to Brexit. The S&P lost almost 6% in the two days after the Brexit vote because the outcome was not expected, but within two weeks, the S&P was hitting new highs.
We believe something similar would happen if Trump wins on Tuesday – a very brief equity selloff (because the markets do not anticipate it happening) followed by a tremendous rebound.
Our recommendation is not to try to time it or to sell in front of the election. After all, Clinton could win on Tuesday, ruining a strategy designed to take advantage of a temporary Trump selloff. Instead, the better option for investors is to decide before the election that if Trump wins and equities dive significantly, it will be a good time to rebalance from cash/bonds into equities.
Let’s say, however, that Clinton wins. How do we expect the stock market to immediately react? Again, the same simple back-of-the-envelope calculation we used above suggests an immediate market rally of about 5.6% from Friday’s close, up to about 2200.
Just look at what’s happening as we write this morning. The market is up after the FBI Director made his third announcement about the investigation into Clinton’s tenure as secretary of state. Now that it looks more likely Clinton is all-clear legally, at least through Tuesday, the market’s assessment of her odds of winning the election are up, and the futures market is up, consistent with recent short-term thinking.
It is tough for us to understand why the markets move up when Clinton’s odds improve and down when Trump’s improve. Both candidates have articulated policy positions which would hurt the economy. However, the odds are overwhelming that either president would face a Congress hostile to most of those policies. The likelihood that either president would be able to seriously hurt the U.S. economy is very low, and – as mentioned above – earnings report are good. Either way, whether Trump or Clinton wins, we think equities are a long-term buy and are still trading below fair value.
Markets move with volatility, but they generally head in the same direction as earnings and economic prospects. This is true now, as it was the last time there was economic angst about the results of a national election. Four years ago, we believed that equities looked cheap regardless of whether Obama or Romney won the election. Since then, major US stock indexes are up almost 50% and that doesn’t even include dividends.
Tomorrow, we all have the hard-won right to participate in democracy. Passions and politics go hand in hand, so there will be celebrations and consolations, but we should never let our personal politics cloud our long-term investment decisions. Whoever wins, the economy will continue to plod upwardly, and markets will reflect that. The gyrations of that upward path can never be timed – yesterday, today, or tomorrow.