By Kevin E. Meier, CFA
Well, it has finally arrived... though I sit in early morning darkness in California, on the east coast, polls are open and have been for over an hour. Hopefully, by this time tomorrow it will all be over.
It seems like we have been waiting around all year, waiting for one event to come and go, just to clear the way to get to the next event (or non-event). But in the end, the statements from the Fed, from Opec, the jobs reports, the inventory data... every so called event came and went, creating a bit of noise then settling down as we all waited for the big event that has now finally arrived. But what all these events have in common, including today's election, is that they are all opportunities for clarity, for someone, anyone, to tell us what is going to happen so we can plan our days and weeks accordingly. And more than anything this year, each opportunity has passed without providing that clarity, with Fed officials, Opec ministers, and macroeconomic data points all kicking the can down the road and delaying the decision making process. That is, until today. Today, hopefully we get some clarity.
And that is certainly what the markets want: not necessarily one particular outcome over the other, just an outcome, a clear, decisive outcome. Some have argued that the US markets have been casting their vote continually, as equities have been selling off as Trump gained ground, and rallying as he gave it up. But to me, it seemed more like a market selling off as the race tightened, as the probability of a decisive victory one way or the other decreased. And as the race loosened, and the probability of a decisive outcome increased, the markets rallied in turn. Indeed, in the last ten trading sessions, we had a whopping nine straight days of losses in US equities as Trump gained ground and the outcome came further into question, followed by a sharp, one-day rally, yesterday, that erased half of the losses of the previous nine days, as Clinton was exonerated and she regained a margin of her lead.
In the past few weeks I have been asked frequently about what I think will happen in the election, most often phrased as "How low do we go on Wednesday if Trump is elected?" For quite some time, I feared a substantial correction, even crash, was highly likely should Trump win. But the more I thought about it, the more it occurred to me why crashes or dramatic sell-offs happen: because of surprises. Brexit is a perfect example, a result that no one thought could happen, with voters, investors, and gamblers all assigning an almost zero probability of the event occurring. And yet a populist movement, fueled by emotion and a mob-like mentality, took hold and did what many thought was impossible, and it took us all be surprise when it did.
So here in the United States, many believed that this election could be our Brexit moment. But that very thought, acknowledging the possibility of a Trump victory, removed the element of surprise. Indeed, as polls tightened and the reality of a Trump presidency increased in probability, the probability of an equity market shock decreased. Investors around the world were given warning, and time to prepare. And prepare they did: selling US equities by the truck load and putting that money into safe havens like bonds, money-market funds, and cash (see Josh Brown's piece Watch What They Do, Not What They Say). Not to mention, buying all sorts of insurance, as made evident by rising VIX levels in a mostly sideways market.
Fund flow data and rising VIX levels show us that people are scared, but are and have been preparing for a sell-off. The fact that the markets were mostly sideways all year belies that preparation; in fact, it has hidden it and presented a false sense of complacency. On the surface, it seems like equity markets in the US have not sold off at all, but very similar to the second half of 2015, the market averages were deceptively buoyed by a small number of mega stocks, while the vast majority of equities have indeed sold off. Amazon and Microsoft and the like have had stellar gains, and those gains have hidden the major decline in the rest of the market.
Now, I have no idea what is going to happen today, nor what the reaction will be tomorrow. But I do think that people are more prepared, emotionally and financially for whatever they believe would be a negative outcome. Therefore, I think the "risk" is if there is a positive surprise, if there is a decisive outcome that ends the kicking of the can. If we get it, it could signal the all clear. We want an outcome, we need some clarity so that we can all stop waiting. Because after all, it is the hardest part.