2 novembre 2016

Assessing the “Trump risk” in a looming contentious US election

Beyond Trump’s detailed economic platform, his election would represent, in the wake of the Brexit vote, a major setback for free trade and another victory for protectionism. A victory for Trump would raise concerns about the legitimacy of the Federal Reserve as Trump called into question the monetary policy carried out by Janet Yellen. Furthermore, globalization would be undermined on a much larger scale than Brexit at a time when leading indicators of global trade indicators have barely improved after four years of retreat (figure 1). In turn, global equities would probably suffer from Trump’s election, while the Mexican Peso would tumble as trade agreement between the US and Mexico would be denounced.

Some real experiment of Hillary Clinton or Donald Trump’s election impact can be inferred from the short term reaction of financial markets following shift in probability for each candidate. For instance, a recent research paper written by Justin Wolfers et al. have showed that the S&P 500 rose 0.7% and the Mexican Peso rose 2% during the first Presidential debate which was consensually won by Clinton. These positive market moves were associated with a shift of 7% probability of winning the election in favor of Clinton (figure 2). The complete election premium in case of the election of Trump would amount to a fall of 12% in the case of the S&P 500 and a staggering tumble of 29% in the Mexican Peso.

Recently, an opposite experiment has been made following the disclosure from the FBI that an enquiry was still ongoing about Hillary Clinton’s use of a private e-mail server when she was Secretary of State. The event triggered a simultaneous drop of equities and the dollar vs. CHF and JPY (figure 3). The most sensitive markets were eventually global equities, the dollar and gold to the upside. The dollar decline vs. funding currencies actually made European and Japanese equities even more sensitive to the possibility of a Trump election. In parallel, gold was clearly chosen as a safe haven asset (figure 4) while Riskelia’s Risk Aversion has risen conveying increased uncertainty over the contentious election (figure 7).

The prediction markets and the elections forecast show a shift in probability between 7% (Predictwise Politics in figure 5) and 18% (538 Politics « Polls-only » model in figure 6). Assuming a realistic shift of 15% of probability in favor of Trump, the total premium associated to Trump would amount to 11% for the S&P 500 and 18% for the Mexican Peso. As only 70% of probability for Clinton is likely to be included (see figure 6), a Trump victory would imply a fall risk of around 8% for equities and 13% for the Mexican Peso.

Financial markets seem to have designed the possible responses to every scenario of an election where mutual hatred and disrespect between political camps is unprecedented:

  • Clinton victory: rise of global equities, rise of the dollar vs EUR, JPY, increase of interest rates, drop of gold.
  • Trump victory: drop of equities, drop of the dollar, collapse of Mexican Peso, rise of gold, fall in rates.
  • Post-Election Overtime deadlock: see the Trump victory scenario and even worse.
     

Figure 1: Leading Indicator of Global Trade (source: Morgan Stanley).

 

Figure 2: Evolution of intraday Future US stocks, the Mexican Peso and the Clinton probability of winning the US election (source: What do financial markets think of the 2016 election, Justin Wolfers et al.) )

Figure 3: Intraday moves of S&P 500, USD/CHF and USD/JPY following the disclosure of the FBI letter about Clinton’s email investigation on 28th October at 1 PM NY time.

Figure 4: Moves of financial markets following the disclosure of the FBI letter about Clinton’s email investigation on 28th October at 1 PM NY time.

Figure 5: Probability of Clinton / Trump winning the election according to Prediction Markets and Polling (source: Predictwise)

 

Figure 6: Probability of Hillary Clinton winning the election according to Nate Silver’s « Polls-only » election forecast model (538 Politics)

Figure 7: Riskelia’s Risk Aversion Heat Map.

For a given asset class, the risk aversion indicator rates the reward market participants require for risk taking. The scores are expressed in numbers of standard deviations to a set of moving averages (from 3 months to 2 years). They are averaged into a Global Risk Indicator representing the global level of risk aversion in the market.