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Over the last couple of days market participants are acting nervously following the recent polls which indicated a close race between the two U.S Presidential contestants. Moreover, a recent poll by ABC put Trump ahead of Clinton by 1 per cent. In actual fact, the uncertainty about Tuesday’s election is undoubtedly pressuring markets particularly equities and selective emerging market FX currencies.
U.S. election
Historically the week before the Presidential election the market rallies. Interestingly enough, if the S&P turns weaker after Tuesday’s close it would be the third time in history out of 23 Presidential elections that the market declined in the week prior to the election. The Mexican peso seems to be the most emerging market FX currency being impacted most by the recent polls and over the past days it emerged as a clear proxy of investors’ perception. Following the ABC poll, the Peso declined by just below 5 per cent, while equity markets on Wednesday retreated from the positive momentum which was brought about by the expansionary Chinese PMI data.
Markets are getting agitated as the policies to be implemented by Trump, if elected, such as huge tariffs on China and Mexico will be detrimental towards the said countries and also U.S. business in terms of trade. In all fairness, the Mexican Peso sensitivity is indeed justified as recent figures showed that just over 25 per cent of Mexico’s GDP are exports to the U.S. Likewise is the impact on the Brazilian real which is pricing the negative impact in terms of exports if Trump holds office at the White House. Movement in yields was also being noted across the sovereign yield curve of the aforementioned countries, as spreads widened in terms of country risk premiums.
On the contrary, Trump’s domestic policies of fiscal expansion such as tax cuts and infrastructure investment might support a small boost to global demand. The other positive which I can envisage is his action to reduce tensions with Russia, which will surely be a positive towards a progress in halting the civil war in Syria. But this is surely not a comfort for the wider phase of Trump’s questioned policies.
Fed’s action
On Wednesday, the Federal Reserve opted to keep interest rates unchanged, as expected by market participants. That said, remarks showed a strengthening argument for a December hike. This led the market to price a 78 per cent probability of a hike. As I have pointed out in my previous articles, technically a hike would be beneficial now for the U.S. economy, primarily for the financial sector, in line with the continuous positive economic data. That said in my view, now more than ever, the Fed, despite technically it should act at its own discretion as it’s an independent function, is now conditioned by the election outcome. Thus a Trump victory, might push the Fed towards delaying December’s rate hike.
Asset Allocation
In terms of asset allocation, undoubtedly this is a major event for financial markets. In my view following the recent polls, a prudent approach would be to raise cash and await Tuesday’s final verdict. Cleary the market is interpreting a Trump’s victory as negative and thus protection of performance through higher levels of cash makes sense. The raised cash would give investors the opportunity to dip-in at favorable valuations, in the event the markets correct on the back of a Trump victory.
On the flip-side, if Clinton gets elected, it’s a positive for markets and thus we should experience a risk-on mode. If the latter occurs, despite investors might lose part of the rally, it would still be rational to participate. Let’s face it, realistically if Trump had to be elected, the downside would be remarkable and thus taking a more prudent approach prior such an important event is surely a rational move especially when polls are now not displaying a clear cut outcome.
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