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Trump Attempts 59-yard Field Goal

PHOTO: US NAVY [PUBLIC DOMAIN], VIA WIKIMEDIA COMMONS

Picking up from my 3rd quarter CIO commentary, Team Trump is running out the field goal unit to attempt a 59-yard field goal in the final seconds of the championship. Team Clinton is up 21-20, so a successful kick wins the game for Trump. From this distance (the ball will be snapped from Clinton's 42-yard line), Trump's kicker has about a 31 percent chance of putting the ball through the uprights, and in turn, his team's owner into the Oval Office. This is what FiveThirtyEight and NFL statistics are telling us.

To state the obvious, the last month of this presidential campaign has been extremely volatile, with the release of the Access Hollywood tape in which Trump makes lewd comments about women, two raucous debates, and the FBI's reopening, and then re-closing, of its probe into Clinton's private email server. Through it all, the probability of a Trump victory fluctuated from about 23% a month ago, to 36% late last week, to 31% now, a day after the FBI re-cleared Clinton of criminal wrongdoing in regards to her emails, and a day before the election.


US Presidential Election Probabilities

 Source: FiveThirtyEight

Source: FiveThirtyEight

The volatility in probabilities gave us a peak into the markets' thinking on the candidates. While both ends of the political spectrum are calling for economic disaster should their candidate not win tomorrow, it's clear who the markets are afraid of winning—Trump. For the first time in my memory, markets are not pulling for the Republican presidential candidate. But this isn't surprising when one understands the economic and trade policy positions of the two candidates. In this election, it is the Democrat who has the more right-leaning, business-friendly policies ,while it is the Republican who has the more left-leaning, protectionist policies.

The chart below shows how US and international equities reacted positively to events that increased the chances of a Clinton victory (Access Hollywood Tape and re-closing of the Clinton FBI email probe), and reacted negatively to the event that increased the chances of a Trump victory (the reopening of the email probe).


Markets Prefer a Clinton Presidency^,2,a,b,c,d

 Source: Google Finance

Source: Google Finance

The VIXe (formally known as the CBOE Volatility Index, a measure of expectations of S&P 500 volatility over the coming 30 days) tells a similar story. One month ago in my quarterly commentary, I remarked at how calm the market was given what I perceived to be a reasonably significant (1 in 4) chance of a large negative event for the markets, a Trump victory. With the FBI's reopening of its probe into Clinton's emails on October 28, and in turn the chances of a Trump presidency, the VIX spiked to 22.5, just shy of the level it hit in the aftermath of the United Kingdom's vote to exit the European Union.


VIX Rises with Trump Victory Chances

 Source: Bloomberg

Source: Bloomberg

From the market movements caused by the reopening, and then re-closing, of the FBI's probe into Clinton emails, we got a feel for how the markets may react tomorrow. The S&P 500's 2% decline as the FBI's probe reopening hit Clinton's election chances by about 12.5 percentage points, and today's 2% rebound on the re-closing of the probe, seems to point to a high single digit, to possibly a double-digit decline in the S&P 500 should Trump win tomorrow. Emerging markets would likely be hit even harder (particularly Mexico and China), and the US dollar would likely sell off by 3-5 percent against the safe-haven currency of Japan. Given today's market rebound and the expectation that Clinton will win tomorrow, we think that market moves to the upside will be modest, perhaps a percent or two for the S&P 500, and less than one percent for the US dollar-Japanese yen.

One event that could cause downside to the two presidential outcomes is if the Republicans retain control of the Senate. Democrats had been strongly favored to retake Senate control, but the Clinton FBI email probe has now pushed the odds over to the Republicans, as shown below in FiveThirtyEight's predictions:


Republicans Are Now Forecast to Retain Senate Control

 Source: FiveThirtyEight

Source: FiveThirtyEight

We think that any Trump victory would very likely be accompanied by Republican majorities in both the House (where Republicans are highly likely to retain control here regardless of who wins the presidency) and the Senate. We think that markets would react very negatively to such an outcome, triggering double-digit losses in the S&P 500. Not only would this outcome give Republicans full control of the Executive and Legislative branches of government, but would also likely usher out Paul Ryan and his more moderate and traditional brand of Republican leadership in Congress. This black swan event would greatly increase the likelihood of what investors so fear from a Trump presidency—economic disruptions and long-term damage from international trade wars, a large increase in government debt from tax cuts for the wealthy, and geopolitical instability as the US withdraws from its leadership position.

We think that markets would look negatively upon on a Republican Senate majority even if Clinton wins the presidency. Although cooperation between President Obama and the Republican-controlled Congress has been non-existant recently, we think it would get worse if the Republican Senate majority mandate is renewed. Usually a split in party control between the Executive and Legislative branches is positive for business and the economy, but an all out Cold War between the two is not. With several prominent Republican Congressman vowing to launch new investigations against Clinton, and to block her federal appointments (including for the Supreme Court), disfunction from Washington is set to continue if Clinton wins.

With market valuations high after a 7+ year bull market, and future risk-rewards scenarios weighted to the downside, AlphaGlider has been defensively positioned over the last year. We feel comfortable with whatever comes our way Wednesday morning. Not much left to do now but sit back, buckle up, and savor the last pitches from the candidates. 😉


NOTES & DISCLOSURES

The views expressed in this commentary are exclusively those of the author, and are not meant as investment advice and are subject to change without notice. The commentary does not have regard to the specific investment objectives, financial situation and the particular needs of any specific person who may receive it. You should seek financial advice regarding the appropriateness of investing in any security or investment strategy discussed or recommended in this report and should understand that statements regarding future prospects may not be realized. There is no guarantee that any investment program or account will be profitable or will not incur loss. You should note that security values may fluctuate and that each security's price or value may rise or fall. Past performance is not necessarily a guide to future performance. Individual client accounts may vary.

1This material represents an assessment of the market and economic environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. Forward-looking statements are subject to certain risks and uncertainties. Actual results, performance or achievements may differ materially from those expressed or implied. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete, and is not intended to be used as a primary basis for investment decisions. It should also not be construed as advice meeting the particular investment needs of any investor.
2Mutual funds, exchange-traded funds and exchange-traded notes are sold by prospectus. Please consider the investment objectives, risks, charges, and expenses carefully before investing. The prospectus, which contains this and other information about the investment company, can be obtained directly from the Fund Company or your financial professional. Be sure to read the prospectus carefully before deciding whether to invest.
^Indices are unmanaged and investors cannot invest directly in an index. The performance of indices do not account for any fees, commissions or other expenses that would be incurred.
aThe Standard & Poor's 500 (S&P 500) Index is a free float-adjusted market capitalization weighted index that is designed to measure large cap US equities. The index includes 500 leading companies and captures approximately 80% coverage of available market capitalization in the US equity markets.
bMSCI Europe, Australasia and Far East (EAFE) Index is a free float-adjusted market capitalization weighted index that is designed to measure the investable universe of developed market equities outside of the US.
cMSCI Emerging Markets (EM) Index is a free float-adjusted market capitalization weighted index that is designed to measure large and mid-cap equity market performance in the global Emerging Markets.
dThe Barclays Capital US Aggregate Bond Index is a market capitalization weighted index that is designed to track most investment grade bonds traded in the United States. The index includes Treasury securities, government agency bonds, mortgage-backed bonds, corporate bonds and a small amount of foreign bonds traded in the United States. Municipal bonds and Treasury Inflation-Protected Securities (TIPS) are excluded due to tax treatment issues.
eThe Chicago Board Options Exchange (CBOE) Volatility (VIX) Index measures the implied volatility of S&P 500 index options. Often referred to as the fear index or the fear gauge, the VIX represents one measure of the market’s expectation of stock market volatility over the next 30-day period.

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