Trump Replaces Fed as Market Worry

The impact of the election has now replaced the Federal Reserve as the major obstacle for financial markets. A Trump presidential victory may cause a significant market selloff, according to recent research conducted by economists Eric Zitzewitz and Justin Wolfers. In their paper, “What do financial markets think of the 2016 election?” the authors looked at currency, stock, bond and options markets globally, and concluded “Given the magnitude of the price movements, we estimate that market participants believe that a Trump victory would reduce the value of the S&P 500, the UK, and Asian stock markets by 10-15 percent...and would significantly increase expected future stock market volatility.”

To put that into perspective, the day after the surprising Brexit vote, the Dow Jones Industrials fell by over 3.4 percent, or 611 points. A ten percent drop would mean a plunge of more than 1800 points! That said, markets recovered swiftly from the post-Brexit losses, so according to Capital Economics, "after a lurch to the downside...we suspect that the fallout for the markets may not last long, while the direct economic consequences would be limited."

While a sudden market drop would certainly be cause for concern for investors, so too would a contested result. Looking back to 2000, when the country had to wait for the Supreme Court to weigh in on a recount, there was a clear negative market reaction: stocks dropping by almost 5 percent during the purgatory period of unknown results.

Meanwhile, the labor market recovery continued in October, as the economy created 161,000 jobs and the unemployment rate edged down to 4.9 percent, mostly in line with expectations. Beyond the headlines, there were three positive data points in the report: the August and September results were revised higher, bringing the average monthly gain for 2016 to 181,000 jobs; average hourly earnings rose, pushing up the annual increase by 2.8 percent, the fastest monthly growth since June 2009; and the broader measure of unemployment, which includes those who have stopped looking for jobs and those working part-time for economic reasons fell to 9.5 percent, the lowest level since April 2008.

At the Federal Reserve policy meeting this week, the central bankers noted that “the case for an increase in the federal funds rate has continued to strengthen, but decided, for the time being, to wait for some further evidence of continued progress toward its objectives.” Consider the October jobs report as further evidence that will help bolster the Fed’s case for a quarter-point interest rate increase at the December 13-14 meeting. Traders are betting on it…according to the futures markets, there’s a 75 percent chance of that outcome, unless of course the markets crash, which might keep the central bank on the sidelines.

There's one more thing to consider as we head into the last weekend before the election. The current economic expansion, while not strong, has lasted 88 months, longer than the post World War II average of nearly 60 months, but still not in the top three longest on record – that honor goes to 1991-2001 (120 months), 1961-1969 (103 months) and 1982-1990 (92 months). Still, given the odds, it is fair to assume that whoever ascends to the Presidency will preside over a recession over the next four years.