Wall Street Might Have a Blind Spot When It Comes to Trumpby
Markets inefficient at pricing in unexpected political events
High voter distrust risks surprise U.S. election outcome
Minutes into last week’s presidential debate, investors decided that Donald Trump, a candidate many of them fear, was being outshone by Hillary Clinton. This, they figured, would help stem his momentum, and so they frantically bid up the value of the Mexican peso, a currency that has become an election barometer. The next day, the S&P 500 Index followed suit, jumping 0.6 percent.
But what if the debate doesn’t really matter? What if it turns out, as many analysts suggest, that support for Trump’s candidacy can’t be measured by developments in traditional election events? Failure to grasp that, they warn, could lead markets into the kind of misstep and turmoil that the U.K.’s vote to leave the European Union did.
“This is an unusual juncture but we keep looking at it through the same kinds of lenses,” said Tina Fordham, Citigroup Inc.’s London-based chief global political analyst. “What if it’s all wrong because society, technology, opinion polling methods, and everything else don’t capture marginalized voters in the way they might once have?”
Fordham said this presidential race feels more like an election in a developing nation where public distrust in government is high and conspiracy theories are rife. Markets seem unaware how much that low trust raises the risk of an anti-establishment vote, agreed Vincent Chaigneau, global head of rates and FX strategy at Societe Generale SA.
The so-called VIX “fear gauge,” which measures future stock market volatility, is way below its five-year average, a clear indication that investors aren’t worried; betting and prediction markets consistently report a likely Clinton victory, which is broadly favored by the markets. The VIX index closed at about 13 on Wednesday, compared with its average value of 16.46 in the period since October 2011.
Traders expect a post-election single-day move of about 1.6 percent for the S&P 500, less than half the average following the past two presidential votes, according to Pravit Chintawongvanich, head derivatives strategist at Macro Risk Advisors. The anticipated move is in line with the historical average dating back to 1968.
“The biggest consensus on the market right now is that we will end up with an easy victory for Clinton and a split Congress in Washington,” said David Woo, head of global rates and FX strategy at Bank of America Merrill Lynch. “I don’t think the market ever thought it was possible that Trump would represent any challenge for her.”
Woo added that apart from assuming a Clinton victory, investors have been preoccupied by numerous other events, reducing their focus on a possible surprise in the election.
Like other analysts, David Rothschild, an economist at Microsoft Research, said markets are unable to understand and price unprecedented, non-economic shocks. A historical look at market reactions to political events shows that when faced with the unknown or unfamiliar, investors bet on an outcome they prefer regardless of its likelihood.
Rothschild, who runs PredictWise, an online forecasting model using betting industry data, said such a preference among traders for outcomes that favor market increases simplifies reality.
“Brexit was just bad for everyone in the market so that led to a certain amount of devaluing that outcome,” he added. “Basically everyone in the market was going to be a loser.”
Regarding a Trump presidency, investors broadly fear his lack of predictability not only on economic plans but also on national security, the analysts noted.
A number of them said national telephone polling data proved off in many recent contests, including Brexit and the Greek and Israeli elections, so they are looking for other measures of public sentiment. Both Woo and Paul Christopher at Wells Fargo Investment Institute say they are paying closer attention to state poll numbers for Senate elections to determine whether they are moving in line with the presidential candidates’ gains or losses.
Fordham at Citi has focused on the Gallup World Poll on public health, which analyzes two decades’ worth of health records of Trump supporters. The numbers show a correlation between the increase in the number of people going through difficult times -- as measured by suicide rates, depression, mental illness and drug addiction -- and the rise in Trump’s popularity, Fordham said.
“This is the kind of thing that investors just don’t normally run into, but it provides another useful way to think about things because income inequality is necessary but not sufficient,” she said. “There is something more subtle going on about public expectations and exhaustion and a sense of corruption, elite abuse of power, and lack of control.”
Rothschild is less convinced than others that the surprise of Brexit is a model for what may happen in the U.S. election. He argues that Brexit was such an unusual vote whereas the U.S. election is a regularly scheduled event with a plethora of dense polling data that will prove to be more reliable.
Woo doubts it, saying the markets are in for a rude awakening. And Fordham says some investors seem to agree.
“I’m getting this Brexit-y feeling and I know other investors are as well,” she said. “The thinking is: I didn’t expect Brexit, so I better assume Trump is going to win. That element of investor psychology is at play here.”