The past few days have been a mix of the expected and unexpected. Last Wednesday afternoon, the Federal Open Market Committee (FOMC) of the Federal Reserve voted to keep its target interest rate unchanged, but also signalled that they will raise rates at the December FOMC meeting.
Both moves were entirely expected and in line with what I advised subscribers of Currency Wars Trader weeks ago.
The Fed will raise rates in December — I’ve been saying that for a long time. Now market expectations have caught up and the coast is clear for the Fed to actually do so.
Some commentators have suggested that a surprise Trump victory in the 8 November election might throw the Fed off its expected path, but it won’t.
It is true that a Trump victory may cause American stocks to decline 10% overnight. But when I discussed this at a recent dinner with Bill Dudley, president of the Federal Reserve Bank of New York, he said ‘it’s not our job’ to prop up the stock market.
He also said he doubted there was much of a link between last December’s rate hike and the sharp selloff in stocks in January 2016.
Apart from the election, all other stars seem aligned for a rate hike. The IMF gave the Fed a green light in terms of emerging-market expectations. Persistently dovish voices such as Charles Evans of the Chicago Fed and Lael Brainard, a Fed governor, have either been supportive of a rate hike or have remained silent lately.
The only thing that could throw the Fed off this path would be if a 10% correction in the US stock market from a Trump win turned into a 15% or 20% collapse with global contagion. However, I expect that once the 10% correction is over, investors will take a second look at Trump’s policies of low taxes, less regulation and big infrastructure spending, and like what they see.
This means stocks may stage a post-election rebound soon after any correction.
But for now, a December rate hike is on the cards, and almost nothing can stop it.
The next thing I want to address is the unexpected speed with which markets are adjusting to the rise of Donald Trump.
Everyone has his or her personal opinion on Trump versus Clinton. If it were just a matter of political views, I would not have to write about it. But the Trump-Clinton election will have a major market impact also, which investors need to watch closely.
I advised my readers weeks ago that markets were in for a shock if Trump wins the election. Markets were fully priced for a Clinton victory, and would have to adjust violently to the prospect of a Trump victory.
I expected this repricing to be compressed in a short window around Election Day from late on 8 November through the early hours of 9 November. I expected stocks to fall 10% and gold to rise over US$100 per ounce.
This process has started, but it is happening in stages over a matter of days, rather than all at once on 8 November.
Since last Friday, stocks are down 1.6% and gold has traded as much as US$40 per ounce higher. This is because of FBI leaks and substantial momentum toward Trump. While the market adjustment to a Trump victory has begun, it is far from over. Stocks have another 8% to fall, and gold is poised to rise another US$60 when the final votes are in.
My expectation is that Trump will win the election on 8 November. However, that forecast is a close call.
The election will be close, and Clinton could win despite my expectation.
Research indicates a Clinton victory should produce an S&P index value of about 2150 points; a Trump victory should put the S&P index at 1950; and an uncertain outcome would split the difference around 2050 points.
If the polls are close, the S&P should trade around 2050, but that’s not what’s going on. The S&P is fully priced for a Clinton victory. That means that if Clinton wins, there will be little or no market reaction, but if Trump wins, the US stock market will hit an air pocket and plunge 10%, to 1950 points, overnight.
Are you ready for an instantaneous 10% wipe-out in your equity portfolio? If not, you should get ready, because that could happen.
If Clinton wins, you can reverse those allocations at low cost. If Trump wins, you’ll make huge profits or avoid huge losses.
This is setting up like ‘Brexit’, where markets were fully priced for ‘Remain’ and hit an air pocket when ‘Leave’ won. Markets and betting odds are not a good reflection of the actual state of play.
If the actual odds of a Trump victory are just better than even money, and markets are priced for sure thing Clinton victory, then we are set up for one of the greatest asymmetric trading opportunities of all time — even better than Brexit.
I use ‘asymmetric’ to describe an opportunity where the outcome may be uncertain but the risk/reward ratio is entirely in your favour. In other words, it’s ‘heads you win, tails you don’t lose’.
The last time we saw this was 23 June, 2016, during the Brexit referendum in the UK Voters had to decide whether to ‘Remain’ in or ‘Leave’ the EU. Markets had fully priced in a Remain victory, but Leave actually won. I saw the mispricing in advance and advised my readers to bet on Leave. Those who did so had instantaneous profits when Leave won and markets violently repriced gold and sterling in favour of my readers.
We’re seeing it again.
Gold, for example, has been priced for a Hillary Clinton victory. Gold fell from US$1,350 per ounce in early September to around US$1,250 per ounce in mid-October based on market perceptions of a Fed rate hike later this year. That was a fundamental move and is easily explained based on changed perceptions of Fed behaviour.
A Clinton victory means more of the same in terms of policy and appointments. If she wins, nothing changes; the price will stay about where it is.
However, if Donald Trump wins, it will be a shock of unprecedented proportions. Gold could spike US$100 per ounce overnight to around $1,400 per ounce based on momentum. If you buy gold, you benefit from this asymmetry. If Clinton wins, you lose little or nothing, but if Trump wins you win big.
I should add, though, that the market is starting to wake up to the opportunity that I’ve been writing about for several weeks. Gold has rallied from US$1,250 per ounce to over US$1,300 per ounce in the past two weeks. In other words, gold is starting to smell a Trump victory.
You can bet on a Trump victory with a variety of very specific trades. But here’s the thing: If Clinton wins, you won’t lose much, if anything, because markets are priced for that. And if Trump wins, you win big because markets will have to instantaneously reprice for an unexpected outcome.
That’s not just my opinion. MIT professor Simon Johnson, former chief economist for the IMF, agrees with me.
Johnson is a member in good standing of the global monetary elite. He says, ‘If investors are wrong and Trump wins, we should expect a big markdown in expected future earnings for a wide range of stocks — and a likely crash in the broader market.’
I agree, but I have no intention of being on the wrong side of that trade.
You should prepare for a Trump victory now, because it’s not nearly the long shot that the mainstream media have been saying it is.
All the best,
For The Daily Reckoning, Australia
PS: This article was originally published in Money Morning.