Trump, Clinton and Investors Playing Long Ball

 So how will the U.S. stock market react to the outcome of the U.S. presidential election?

There’s only one right answer: “Who knows?” But that hasn’t deterred speculation about what the market will do when the bell rings on Wednesday morning, and in the days and weeks that follow.

What’s amazing to me about all that speculation is that there isn’t more disagreement. The consensus seems to be that the market will mostly yawn if Hilary Clinton wins, but that it will melt down if Donald Trump wins.

That view has been reinforced in recent weeks, as U.S. stocks have retreated along with Clinton’s chances of winning the White House. According to statistician and election prognosticator Nate Silver, Clinton’s chances last peaked at 88.1 percent on October 17 and have steadily declined to 64.5 percent as of Friday. The S&P 500 is down 1.9 percent over that period.

And that raises another question: Is the market truly reflecting the changing fortunes of the candidates, or is that just a coincidence?

To find out, I compared the daily changes in Clinton’s chances of winning the election — as estimated by Silver — with the daily price changes of the S&P 500. I discovered that there was a zero correlation between the two from June 9 through Friday (the longest period for which data is available). So at first glance Clinton’s rising and falling fortunes have had no discernable influence on the direction of the stock market.

When I looked at that same correlation over rolling 30-day periods, however, I discovered that it has moved considerably over time. The correlation during the first 30-day period was a negative 0.15, which means that the market tended to rise when Clinton’s chances declined, and vice-versa. But the correlation during the most recent 30 days through Friday was a positive 0.22, which means just the opposite — the market tended to rise and fall along with Clinton’s chances of winning.

As election day nears, in other words, it looks more and more like the market’s fortunes are influenced by Clinton’s fortunes, as many investors fear.

Okay, so let’s assume that the market won’t like a Clinton upset. What, if anything, should investors do about it?

Well, it happens that our U.K. cousins recently faced a strikingly similar decision. Many observers have likened Brexit to the U.S. election, and for obvious reasons. Like Brexit, the U.S. election is in large part a choice between remaining engaged with a larger world community or turning our backs to it. Like Brexit, the polls predict that America will choose to remain engaged. And like Brexit, it’s widely feared that the stock market will not take a surprise to the contrary very well.

The numbers are eerily similar, too. The FTSE 100 Index peaked nine weeks before the Brexit vote on June 23. As the vote neared, so did investors’ anxiety about the outcome. The FTSE 100 was down 7.2 percent a week before the vote from its peak on April 20. Here in the U.S. investors have been increasingly anxious as election day nears. The S&P 500 peaked 12 weeks ago on August 15, and the index is down 4.8 percent since then through Friday.

Given those similarities, it seems reasonable to wonder what post-election lessons might be learned from Brexit.

The first — and most obvious — is that the market’s initial reaction to a Trump presidency may not be pretty. Markets hate surprises, and by the end of the second trading day following the U.K.’s decision to leave the EU, the FTSE 100 was down 5.6 percent.

The second — and far more noteworthy lesson in my estimation — is that the market’s reaction the day after the election is not necessarily indicative of what will happen a week or a month later. U.K. stocks took off on the third trading day following Brexit. The FTSE 100 is up 11.9 percent since then, or 5.6 percent since Brexit. Getting out of U.K. stocks ahead of Brexit has so far turned out to be a very expensive insurance policy for nervous investors.

It makes sense to be humble about post-election market predictions. But even so, I also think that ditching U.S. stocks because of the election may actually turn out to be unnecessarily costly.

Source: Bloomberg Gadfly,