Hypothetical Post-Election Returns

Why you should take US post-election market projections with a grain of salt.

Editors’ Note: Our discussion of politics is focused purely on potential market impact and is designed to be nonpartisan. Stocks don’t favor any party, and partisan ideology invites bias—dangerous in investing.

We are less than a week away from Election Day, a welcome relief for those weary of all the antics and hijinks of this year’s presidential race.i However, the punditry shows no signs of quieting, with analyses covering everything from tax policy to immigration. Naturally, economic and market projections of a Trump and Clinton presidency exist, too, and one paper in particular has been making the rounds. It claims to show Clinton would benefit the global economy—and boost markets—while a Trump presidency would harm them. To us the study suggests a host of investing errors—myopia, extrapolation, straight-line thinking and more. Regardless of your political preference, we strongly urge against making investment decisions based on this sort of thinking. This just isn’t how markets work.

The paper in question estimates the S&P 500 would be worth 12% more under a President Clinton, with less volatility. A barrel of oil, we’re told, would be worth $4 more, US Treasury yields would be 25 basis points higher, and the Mexican peso would be worth almost 30% more versus the dollar. Which is a very specific forecast indeed! But as with so many things said during this presidential race, a little fact-checking unearths some questions. To start with, how was that very specific forecast cooked up?

Those projections were based on certain securities’ returns during the first presidential debate on September 26, which Clinton “won” based on polled groups of undecided voters in swing states like Pennsylvania and Ohio.ii The study provides a quick summation of those assets’ performance: Equity futures for domestic (e.g., S&P 500, Nasdaq 100 and Russell 2000) and foreign (FTSE 100, ASX, Hang Seng and Nikkei) indexes all rose; prices for fixed income futures (2-year, 5-year and 10-year Treasurys) fell, implying an expectation of rising interest rates; commodity futures (e.g., Brent and WTI crude oil) were up; currencies like the Mexican Peso and Canadian dollar strengthened vs. the US dollar; and futures for the CBOE Volatility Index (the VIX or “fear” gauge) declined, implying lower expected volatility. Based on these factors, the report argues investors expect a stronger, less uncertain and more trade-friendly economy under a President Clinton than a President Trump. The economists further noted similar market behavior when the “Trump Tape” was released over the October 7-9 weekend. However, we don’t view this as clear evidence markets prefer Clinton over Trump.

While we agree markets look forward and start pricing in new information immediately, there are some important caveats here. For one, this analysis depends heavily on futures markets data. While the reactions of one group of traders shouldn’t be outright discounted, futures markets aren’t more indicative than other similarly liquid markets. Consider what broader markets have done in the month since that first debate. US stocks are up just 0.2%iii—a hair above flat—which isn’t very telling. Currency-wise, the Canadian Dollar gained 1.3% against USD while the Mexican Peso fell -6.1% over that same time—a stark divergence from their simultaneous rise on September 26.iv Both WTI and Brent crude are up, but still trade within the $45 – 50 range they have since May.v Also, Trump has fallen further behind in the polls since September, so if markets were truly cheering a Clinton presidency, shouldn’t they all be repeating what the futures markets did during the debate, reflecting the excitement over her widening lead?

Which brings us to another important point: The timeframe of Monday, September 26 from 9pm – 11pm EST is ultra-myopic and strange. Though the paper touts this narrow time period as a positive because it isolates the debate’s market impact, thereby minimizing outside influence or noise, we question that effectiveness. Consider: Who is trading on a Monday night? Most major Western developed capital markets are closed at that time, leaving mostly Asian markets open. You aren’t getting what “the market” thinks. Rather, you’re getting what a specific subset (futures traders) of the market thinks. In the Brexit vote, the abject failure of markets to foresee the vote’s outcome was tied to this very factor—the sample wasn’t representative. Here, we’d suggest the sample isn’t representative of investors and traders overall.

Besides the limitations of futures markets data, we also take issue with the economists’ other assumptions. They extrapolated the S&P 500 futures’ 0.7% rise during the debate to mean stocks would be worth 12% more under a President Clinton—and therefore -12% less under a President Trump. However, straight-line math both here and with the other projections assumes everything stays static moving forward—a fallacy, since both expected and unexpected events alter projections constantly. Another fallacy is assuming a President Clinton or Trump will definitively act in known ways. However, to highlight one example, Trump’s bombastic protectionist rhetoric doesn’t mean the US is about to cut itself off from the global economy if he wins office. Words don’t equal action, and politiciansvi make all sorts of wild promises when campaigning, only to moderate once in office. They need to maintain their appeal for the next election, and the other branches of government keep their power in check, too.

For investors, we strongly advise against divining too much from these types of analyses. At its core, this paper argues that global markets and the US economy will behave in a given manner based on limited trading activity during a couple hours by a niche group of people on a Monday night in September and a weekend in October. Though we highlighted this study in particular, it isn’t the only one attempting to game future market behavior under a Clinton or Trump presidency. We understand the desire to find meaning, and thus, more certainty. However, one highly publicized verbal exchange can’t meaningfully alter the near-term outlook of stocks and the economy. This understates the complexity and depth of global capital markets—US presidential politics are pretty far from the only driver.

Rather than speculate about what one candidate or another will do for stocks, we suggest investors turn their attention to what really matters: the gap between expectations and outcome. We have discussed the “Perverse Inverse” before—markets’ tendency during presidential election years to outperform when a Republican wins, only to disappoint the following year because reality doesn’t live up to the hype. This year, however, there isn’t the typical GOP “market friendly” candidate. While Clinton elicits the typical worries about a Democratic candidate, Trump’s uniquenessvii garners a similar type of uncertainty and concern from investors, which the popularity of this study sort of highlights unintentionally. This uncertainty has likely weighed on market returns this year, but it also sets up a positive surprise for next year. Once markets realize neither Clinton nor Trump will be able to ram through the big changes they tout on the campaign trail—both candidates are extremely unpopular and likely face an unreceptive (at best) Congress—the relief of a do-little Clinton/Trump presidency likely pushes stocks higher. So as scary and tiresome as US politics have been for the past year, we don’t see any reason to change our bullish stance—and we believe investors will be best served by staying disciplined and invested.

iAlthough this probably just kicks off the 2018 midterms. Whee?
iiWe put “won” in quotes because there is no definitive metric we’re aware of to score these presidential debates at home. If you were looking for substantive discussion on policy, however, you likely didn’t win.
iiiSource: FactSet, as of 10/26/2016. S&P 500 Total Return Index from 9/26/2016 – 10/26/2016.
ivIbid. Mexican Peso per USD and Canadian Dollar per USD, percent change from 9/26/2016 – 10/26/2016.
vSource: FactSet, as of 10/27/2016.
viWhile Trump doesn’t have political experience, many argue he is a great businessman, and compromise is integral to successful business. Though many others also argue whether or not the Republican nominee has that great a track record in business.
viiAnd how!

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