Investor warning: A trump victory is a 'brexit times ten'
Posted on: 4 Nov 2016

Investor warning: A trump victory is a 'brexit times ten'

What do new RBA governor Philip Lowe and US presidential candidate Donald Trump have in common?

Both agree that a surprise election result next week will have much greater ramifications for financial markets than Brexit.

Investors obviously agree. As Trump's stocks have risen in recent times, stockmarkets have tumbled and money has poured into traditional safe havens such as gold.

The S&P 500 has suffered eight consecutive sessions of losses, its longest since, coincidentally, the US presidential election in October 2008.

Well, maybe not so coincidentally – analysts have pointed out that it's not unusual for investors to be cautious around such a major event, and for volatility to rise.

What's different this time is that the market has decided that a Trump win is the big risk event, while a Clinton win should spell business as usual. In other words, the outcome is binary: does Trump win or not?

Of course much depends on whether Congress remains split between Democrats and Republicans after the vote, but these are nuances the market is not overly concerning itself with now.

The good news for investors is that relief should come Wednesday afternoon, with Clinton likely to win the bitterly contested US election.

The removal of the wild card Trump from the equation should soothe market nerves and reverse some of the recent moves.

Relief rally

Expect a relief rally in the ASX, and a higher Aussie dollar. Maybe some selling in bonds. We can get on with obsessing over the Fed's likely rate hike in December.

But until then, markets are going to stay jittery. Trump may not be the favourite, but his chances of winning are certainly far from negligible.

On election day and in the coming days, PIMCO's head of public policy, Libby Cantrill, recommends investors focus less on national polls and more on state-level numbers.

Americans elect their presidents through the Electoral College rather than the popular vote, and electoral votes are determined by individual states.

"Between 10 and 12 of battleground states are important, but arguably only a subset are truly critical to get to the needed 270 electoral votes to win the White House," Cantrill writes, highlighting Florida, Ohio, North Carolina and Pennsylvania.

"That is because Donald Trump would have to win all four if Clinton maintains her relatively healthy leads in the battleground states of Colorado, Virginia, Michigan and Wisconsin."

There are various permutations, but the PIMCO analyst breaks it down to what is very likely to be the key: Trump needs to win Florida to have any reasonable chance of prevailing overall. Similarly, most pathways for a Clinton victory require her to win Pennsylvania.

So while a Trump victory may be unlikely, it's still a clear possibility, and that is what investors are trying to price in.

So what would the impact on markets be? Investors may be tempted to use June's Brexit vote as a playbook for a Trump victory.

After all, Britain's decision to leave the EU was never going to happen – until it did. And if Brexit represented "the people" blackening the collective eye of the "ruling elites", then the pugilistic metaphor extends handsomely to the Trump campaign.

The Brexit playbook

If Brexit and a Trump presidency are indeed equivalent, then the strategy runs like this: wait for the initial sell-off and then buy sold-down assets with your ears pinned back.

The US Fed will act quickly to reassure the market by announcing, like the Bank of England did, that it stands ready to do what it takes to keep financial markets from a damaging bust.

Then US high frequency data will suggest the feared hit to the economy was overblown. Who knows, just like after Brexit, the S&P 500 could be hitting new highs in a few weeks' time.

If that sounds incredibly optimistic, it's because it is. There are reasons to think that the ramifications of a Trump presidency go way beyond the UK's decision to leave the EU (the impact of which has not even really begun).

At a rally this week, Trump himself boasted of an electoral upset equivalent to "Brexit times 10" (a week earlier it was "Brexit times five"), and he's right that the fall-out would be many orders of magnitude greater than the British referendum.

"We agree that the global economic and financial market response to a Trump win would be greater than for Brexit," Westpac economist Sean Callow says.

"A Trump presidency would bring about the biggest changes in many decades in existing US arrangements on everything from taxation policy to trade policy, social spending, immigration and geopolitics."

The uncertainty is the killer. It's not clear that even Trump knows what he will do. His rhetoric is fierce, but his policy details are scant.

While Trump has been wildly inconsistent on many policy details, Callow points out that he has held "somewhat steady" positions in three key areas.

They include a commitment to significant tax cuts, trade protectionism and immigration restrictions. Unfortunately Callow concludes that "on balance, Trump's key policy proposals would do a lot more harm than good".

Recession sooner or later

Citi's US economics team reckons "Trump's more isolationist and protectionist ideas on external trade and immigration, if realised, suggest a US recession sooner or later".

Well, a recession is always coming "sooner or later", but the point here is that Trump's policies will be the catalyst.

Citi analysts think the S&P 500 will fall 3-5 per cent on the next session if Clinton loses, and we would likely get a similar hit here.

The yen and Swiss franc would be bid higher again, while the currencies of trade-dependent emerging countries would take a hit on fears of rising protectionism. The Aussie could drop towards US73¢, Callow estimates.

The impact on the US dollar and bonds is less clear. Uncertainty might spark some capital flight, which would push both lower, but a wholesale meltdown in global risk assets traditionally sees buying of greenback and Treasuries.

But perhaps the greatest question mark for investors in the weeks and months after a Trump victory will be the Fed's ability to step in and steady the boat.

A December hike might be quickly ruled out, but Trump is an outspoken critic of the US central bank, its chair Janet Yellen, and its policies.

If investors begin to factor in a much reduced capacity by the Fed to intervene in the market under sustained attack from the new president, then it's hard to imagine that we are in for an easy ride.

Source: http://www.afr.com/personal-finance/investors-beware-a-trump-victory-is-a-brexit-times-ten-20161104-gshxcf