President Trump? Traders Aren't Sure How to Prep for Thatby
They see levels of political uncertainty soaring in 2016
The eighth year of a presidential term is worst for stocks
If markets hate uncertainty, this year’s U.S. presidential elections have the potential to provoke full-blown contempt.
As if it weren’t hard enough to trade as growth stagnates and commodities plunge, investors are starting to complain that they lack a blueprint to navigate contests in which Donald Trump has emerged as a surprisingly strong frontrunner for the Republican nomination and Bernie Sanders, an avowed socialist, poses an ongoing threat to Democratic rival Hillary Clinton.
This much is known: the eighth year of a presidency ranks last in terms of equity returns, and that the first half of an election year is often even worse. Add everything else that has been weighing on markets in 2016, from China to oil and the Federal Reserve, and few money managers see a return to the calm that reigned from 2012 to 2015.
“There’s this fragmentation that’s throwing up a lot more variables than the market can contend with at the moment, and central banks are no longer filling that policy vacuum,” said Michael Ingram, a market strategist at BGC Partners in London. Political uncertainty is a “wholly unwelcome variable” and Trump’s viability is only now “starting to creep into the investment calculation,” he said.
After a dominating victory in the Nevada caucuses, Trump’s candidacy heads into the Super Tuesday contests next week with a boost that leaves investors with a question many see as unanswerable: What does it mean for markets? Trump has outlined stances on immigration reform, domestic job creation and even a boycott on Apple Inc., while Sanders’ proposals could boost capital gains taxes above 50 percent.
Uncertainty around this election has become the biggest question that David Rubenstein, the co-chief executive officer of private equity firm Carlyle Group LP, has been fielding recently, he said at the SuperReturn International conference in Berlin this week.
As former chairman of the Republican National Committee, Ken Mehlman, now a partner at investment firm KKR & Co., also can’t escape inquires. “It’s certainly a crazy cycle on both sides,” he said Wednesday.
“It’s a very, very scary year,” Guy Hands, the founder of private equity firm Terra Firma Capital Partners, said Wednesday in an interview from Berlin. “You have a U.S. election where Trump is continuing to defy expectations and people in Europe have no idea what that would bring.”
It isn’t unusual for markets to struggle in the first half of presidential election years, with the Dow Jones Industrial Average falling an average 1.8 percent through May, data going back to 1900 compiled by Ned Davis Research Inc. show. The timing of the market’s bottom is linked to when the winner has become clear, the study found.
For instance, in 1996, when Bill Clinton’s re-election was in little doubt, the Dow average reached its low in January and the market suffered only one pullback of more than 5 percent. In 2004, when George W. Bush was in a tight race with John Kerry, the market didn’t make its low for the year until October after four bouts of selloffs exceeding 5 percent, according to Ned Davis Research.
“This political cycle is filled with more drama than usual. The extremity of a Trump or Cruz or Bernie creates the illusion that the winner is going to be more of an extreme character,” said Hayes Miller, the Boston-based head of multi-asset North America who helps oversee $35.8 billion for Baring Asset Management LLC. “The market is playing a probability game and as the probability becomes more clear, then the market is able to discount that easier.”
Volatility has ruled equities so far in 2016, with declines in the S&P 500 swelling past 10 percent as the gauge hit a two-year low on Feb. 11. U.S. small-caps and global equities have tumbled into bear markets, while the S&P 500 has posted daily gains or losses exceeding 1 percent on 22 of the first 35 days -- about 63 percent of the time. That happened 28 percent of trading days in 2015.
For equity investors, a Trump presidency could conceivably benefit defense and homeland security companies, infrastructure builders, and consumer discretionary companies, should he fulfill his pledge to cut taxes on low- and middle-income workers, according to a note Wednesday from Strategas Research Partners LLC. A Sanders presidency? He has proposed breaking up banks deemed too big to fail, creating a single-payer health-care system and reversing the North American Free Trade Agreement, Strategas said in a note on Feb. 10.
For currency traders, it’s too early to say whether the candidates would boost or hurt the already-strong dollar. “It’d be very hard to trade a U.S. political story right now, whether it’s Trump or Sanders. It’s premature, it’s uncertain, there are just too many factors,” said Adnan Akant, head of currencies in New York at Fischer Francis Trees & Watts Inc., which has about $38 billion under management.
The possibility of an independent entering the contest, triggering a three-way race, could exacerbate uncertainty risk if the challenger looks likely to win one or more states, David Kotok, chairman and co-founder of Cumberland Advisors, which manages $2.4 billion of fixed income in Sarasota, Florida, wrote in a Feb. 22 note to clients.
Mike Bloomberg, the former mayor of New York, is exploring a third-party bid, while Trump hasn’t wholly dismissed the possibility of running as an independent if his party bid comes up short. Bloomberg is the founder and majority owner of Bloomberg LP, the parent company of Bloomberg News.
“What the election cycle is doing with regard to the introduction of third-party candidates and disarray in both parties is pushing peoples’ perception of risk up,” said James Abate, who helps oversee $1 billion as chief investment officer at Centre Funds in New York. “When that happens and interest rates stay relatively flat, that means the P/E multiple people are willing to pay for a string of earnings goes down.”
To be sure, both have supporters in financial circles -- Carl Icahn has endorsed Trump and former Labor Secretary Robert Reich did the same for Sanders. And both have risked alienating swaths of Wall Street with proposals to close tax loopholes used by hedge funds.
To gauge the level of unease in the market just look at gold, says Greg Taylor, a fund manager at Aurion Capital Management in Toronto, which manages about C$7.2 billion ($5.2 billion). The commodity is up more than 17 percent this year, while an exchange-traded fund of mining companies has surged 42 percent.
“You’re seeing massive inflows into gold stocks and that’s a sign something might be different,” Taylor said. “Whether that’s the fear trade from politics or negative rates, that’s the biggest trade.”
Similarly, oil has dominated day-to-day movements in equities and that relationship continues to overpower any potential political trade for the time being, said Sandy Villere, a portfolio manager at Villere & Co. in New Orleans, which oversees $2.6 billion. “Once oil settles down, people are going to start to focus on this presidential election even more so than they are today.”
With more than eight months until election day, that only leaves more time for surprises in an already-unusual race, be it from third-party contenders or shake-ups among the current leaders.
“The longer there remains uncertainty in the election cycle, the more it can start to creep into investor sentiment and expectations around policy and that can facilitate more volatility,” said Bill Merz, senior investment strategist at the Private Client Reserve at U.S. Bank in Minneapolis, Minnesota. “The sooner there is clarity and the range of outcomes narrows further than the volatility and risks starts to dissipate -- we haven’t seen that yet.”