According to popular U.S. statistician Nate Silver's fivethirtyeight.com, the odds of a Clinton White House is down to 65.6 per cent as I write this article. Two weeks ago, before the latest e-mail saga, Ms. Clinton was pushing 90 per cent and Donald Trump was essentially done. In the Senate, it looks like Democrats will swing five states blue and regain control. Other prognosticators have similar forecasts.
We see the economic problems in the United States as troubling. The median family income in the 1970s was about $48,000 (U.S.) and adjusted for inflation for comparison purposes, it's about $53,000 today. There have not been any real and meaningful economic gains for the middle class for decades. The average chief executive officer has seen their income go up 1,000 per cent and the top 10 per cent owns about 90 per cent of the assets. Government policies to stimulate the economy these days are leaving more and more in the bottom half while those with most of the assets are thriving. More than 43 million receive the supplemental nutrition assistance program (food stamps), more than double the historical average as a percentage of the population.
What the odds makers and pollsters missed in the U.K. Brexit surprise, that they have likely missed here, is how disenfranchised an increasing part of the population has become. In Britain, the rural voter showed up to vote, while the city dwellers opting for the status quo did not. We can see a similar outcome in this election that the pollsters are missing. I'm not an expert in political forecasting, but I do manage market risk and ignoring this "political game-changing" outcome should not be ignored. I would not dismiss this potential outcome. Mr. Trump is not like any candidate before and a protectionist swing by the United States would likely have lasting systemic growth implications at a time when the world is already growth-challenged.
There is a clear asymmetric risk in the U.S. election outcome and few are ready for what a Trump White House and Republican Congress means. Initially, the shock would be probably far, far worse than Brexit. Global equity markets fell about 8 per cent in the two days following Brexit and despite having bounced back relatively quickly, the world equity index as measured by the Vanguard Total World Stock Index Fund is lower today than it was on June 23 – the day of the Brexit referendum.
The best market scenario is a Clinton win, which is expected, and a Republican Senate and House of Representatives, as independents will want the checks and balances down ticket. Being largely priced in, I do not expect more than a post-election relief bounce that should fade in December as the Italian referendum and U.S. rate hike trump (different trump) a status quo result.
An asymmetric risk is where the outcomes are skewed. A positive outcome – that is, a Clinton win and GOP Senate and House – might be worth a week or two of market strength. Probably to something less than recent highs, or about 3 per cent to 4 per cent. The worst-case scenario is probably a GOP sweep. Uncertainty around trade policies could put global capital expenditures and budgets on hold for the next year. If I were the chief executive officer of a Fortune 500 company, I'd pause while the marketplace determines how protectionist the world could get.
We simply do not know what tack Mr. Trump would take if elected, but we have a pretty good guess. If we add to this that the global implications from Brexit negotiations that could begin next March, followed by French elections in May, where the odds of an anti-EU leadership is very real, you have a scenario where there is an alternative to equities for some time. You do not pay 20 times earnings for uncertainty – but that doesn't mean you go out and sell all your stocks. Ms. Clinton will probably win, but if she doesn't, a little insurance might be a good idea. Learning a bit about how to hedge your portfolio or asset allocation techniques between lower correlated assets could help smooth out the ride.
In the worst-case scenario, gold (such as Claymore Gold Bullion Trust or SPDR Gold Trust – tickers CGL and GLD, respectively) would almost certainly break recent highs and long U.S. Treasuries (such as iShares 20+ Year Treasury Bond ETF – ticker TLT) should have a strong rally as it would take the possibility of a Fed rate hike in December off the table instantly. And when I say gold, I mean bullion, as gold stocks fell 50 per cent after the Lehman moment in 2008. I would expect a few months of equity market weakness taking global stock markets at least 10 per cent lower in short order, and probably several months of weakness to follow. Recent lows in the S&P 500 in the past few years around 1,800 would certainly be challenged.
Sophisticated investors may consider using the volatility-based securities such as the iPath S&P 500 VIX ST Futures ETN (VXX), the Horizons BetaPro S&P 500 VIX Short Term Futures Index ETF (HUV), or Horizons BetaPro S&P 500 VIX Short Term Futures Bull+ ETF (HVU) – for a short period (days to weeks) to help protect portfolios. The VIX itself spiked to 26.5 following Brexit, I would expect it to spike above 30. The January VIX futures contract is trading at about 19, so there is potential for a 50-per-cent plus rally in the unleveraged VIX ETFs.
On the other hand, a Clinton win would likely see volatility futures fall at least 10 per cent on Nov. 9.
Larry Berman is co-founder of ETF Capital Management. He is a Chartered Market Technician, a Chartered Financial Analyst charterholder, and is a U.S.-registered Commodity Trading Adviser.
Tune in to Berman's Call Monday's at 11am ET or catch one of my upcoming talks at a city near you on how you can better manage your portfolio. Follow me on Twitter, on Facebook, at www.etfcm.com or on Berman's Call Monday's at 11am ET.