Political risk here to stay
Many investors detest uncertainty. For good reason; change breeds unpredictability. Politics is a source of great insecurity in this day and age. Increasingly so, it would seem. Virtually nobody foresaw a year ago that the 2016 Republican US presidential candidate would go by the name of Donald Trump. When Brexit happened in June the opinion polls were widely off the mark regarding the outcome of the referendum. There is also the uncomfortable fact that whereas further terrorist attacks in the West are almost a given, nobody can say when, where, or how the next one will take place. The coup attempt in Turkey is another development that many analysts did not anticipate.
Political uncertainty will not disappear in the next few months with among many other events Russian elections in September and two important referendums and another election in Europe in October that will reveal how fertile the populist breeding ground still is. Of course by then The Greatest Election Show on earth is under way.
Donald vs Hillary - Let the games begin!
The US dogfight started in earnest this week when Trump sealed the nomination at the Republican Convention in Cleveland. Hillary-bashing was a staple ingredient of the speeches that were read out by a motley crew of Trump family members, B-list celebs, and subclasses of the GOP (apart from the Republican heavyweights who had to be present in an official capacity). The Democrats will have their own celebration next week that will last a couple of days as Clinton is declared the official candidate. The months ahead will probably be a rollercoaster ride sprinkled with embarrassing moments. Most bookies and analysts believe that Clinton has a leading edge as she hops aboard but keep in mind the wrong predictions regarding Brexit and Trump as a likely contender for the White House.
The Underbulldog
So what do these global developments mean for the financial markets? Our economists are neutral on equities although they are relatively upbeat on the US within this asset class. It makes sense politically unless the polls start to point to a Trump victory in November. For now, we think the most probable outcome is a Democratic White House and a divided Congress (the GOP dominates the House of Representatives whereas the Democrats secure the Senate). This would make it harder to take decisions. On the other hand, the US economy is already doing quite well. Plus, the markets will be reasonably content if Clinton makes president and Congress is divided. From this angle, there are few reasons to assume that US equities will go down sharply over the coming months.
The prospect of a Trump White House would make a fundamental difference as his protectionist, isolationist, and impulsive tendencies do not sit well with the markets. The Republican candidate has recently made gains and investors could lose their nerve in view of his ideas regarding free trade, NATO, sealing the Mexican border, and the Fed (among others).
The Trump Hedge
Investors can buy put options on equities to hedge against a Trump presidency. After all there is a fairly high chance that the US stock indices will respond negatively. If he wins the US will likely look inward and try to turn its back on the world. A short position on the Mexican peso could be a solution considering Trump's aversion to the free-trade agreement between Canada, Mexico, and the US (NAFTA) and his plans to build a wall at the Mexican border. We should mention that the peso has depreciated substantially against the dollar since 2013 so the remaining downside potential is unclear. Perhaps the Fed will cut its key interest rate following a Trump victory. This would weaken the dollar.
Aside from the currency market, the oil and defence sector would be a logical choice for investors that fear a Trump Presidency. Donald does not believe in climate chance. His tough rhetoric on the Middle East would mean that the aforementioned sectors will be very attractive, should he swap the Trump Tower for the White House. He said in June that, "I say that you can defeat ISIS by taking back their wealth. Take back the oil. Once you go over and take back that oil, they have nothing. You bomb the hell out of them, and then you encircle it, and then you go in. And you let [ExxonMobil] go in." A stint with Trump at the helm will also benefit the handgun industry; he is a far more enthusiastic promoter of the right to bear firearms than Hillary Clinton.
Political risk will be a mainstay for the remainder of 2016, but fortunately there are plenty of ways to profit from one of the biggest political risks this year: a Trump presidency.