Welcome to Election Day 2016. I for one am unable to conjure any emotion other relief that it’s over.
There will be plenty to read and watch today, so let me keep this very short.
- Through last Friday, the markets looked into the eyes of the presidential election and blinked. The S&P 500 ended last week with its longest losing streak since 1980, closing down for nine consecutive trading sessions, ending the week at 2085.18, up only 2.02% for the year.
- However losses were a relatively modest -3.1% during this period, so while investors had been clearing out of the market before Tuesday’s election, they had been doing so in an orderly manner.
- To place the recent loss in perspective, the S&P 500 has lost a greater percentage in a single trading sessions 295 times since 1928 than it has since it started thinking that it might have to utter the words “President Donald J. Trump” on the morning of November 9th.
- Then on Sunday, FBI Director James Comey let Hillary Clinton off the hook for a second time. This set off a giant rally on Wall Street with the S&P 500 closing up over 2%. Markets have long favored a Clinton presidency on the basis that the Devil they know is better than the Devil they don’t.
- It also looks increasingly likely that Republicans will maintain control of the Senate, which gives investors comfort that if Mrs. Clinton does pull off a victory, she will not be able to raise taxes or push through her anti-business agenda.
- We will learn today if markets got ahead of themselves on Monday. Trump still has a narrow path to victory through Florida.
- If Trump wins today: As I explained yesterday, equities could sell off sharply as investors wrestle with an outcome that was not priced in to the market. In that case, we can expect many of our favorite short positions to head straight down.
- If Clinton wins today: The relief rally that many expected may continue but likely not for long as her victory sends the country straight into political paralysis and constitutional crisis that leaves us vulnerable to geopolitical and economic threats.
- Either way: Since market valuations are already extended, any sell-off could be serious until cooler heads prevail.
My Full Election Day Market Analysis
Junk bonds are also in the middle of a bad run though the losses are manageable thus far. The BofA Merrill Lynch U.S. High Yield Index has dropped by 1.8% since October 24, and investors have redeemed billions of dollars from high yield ETFs. Junk bonds are still enjoying a very strong year (despite rising defaults and poor risk-adjusted returns that extend beyond the troubled energy patch) but are giving some of those gains back based on the same concerns that are spooking equity markets.
Markets may also be growing tired of being told that the economy is wonderful when it is decidedly not. Despite phony government statistics that report a low unemployment rate of 4.9%, there are 96 million people out of the work force and the quality of jobs being created is poor. Non-farm payrolls rose by 161,000 in October, another in a long line of woeful numbers in a country of 320 million people. Private sector jobs increased a mere 142,000, 28,000 less than expected, last month. And 195,000 more of our fellow citizens left the workforce, dropping the labor-force participation rate to 62.8%. Much of this has been made possible by the expansion of the Dependency State by the Obama Administration, which lowered eligibility requirements for virtually every type of government freebie in existence.
As ObamaCare unravels just as its architect conveniently leaves the scene of the crime, America faces the challenge of reversing the unsustainable expansion of unaffordable entitlements that are busting federal and state budgets. In the fiscal year that just ended in September, the annual federal deficit jumped to $560 billion but the federal debt jumped by $1.4 trillion because many budget items are “off balance sheet.” With the federal debt about to hit $20 trillion, having doubled during the Obama years, it won’t take long before it hits $25 trillion and more and the country is spending $1 trillion just on the interest on the federal debt. Anyone who believes that interest rates will remain at their artificially low levels regardless of what the feckless Fed does is fooling himself. The only way interest rates will stay low is if we have another credit crisis, which is increasingly likely to happen but only after rates rise and trigger that crisis. The next president may not be inheriting an immediate crisis, but he is facing a crisis nonetheless.
The press continues to write about hedge funds losing money and investors but misses the most important point of the story – these investment partnerships are not “hedge” funds. With very few exceptions, they are long-biased funds that charge hedge fund fees (meaning a management fee plus a performance fee). Such fees are only appropriate for uniquely skilled managers or for unique investment strategies that protect capital in down markets, something that very few funds are capable of doing. Reports that some of the largest funds in the world such as Crispin Odey (down more than 40% this year), Pershing Square (down 20% for the second consecutive year) and Paulson & Co.’s funds (which have lost money all but one year since the financial crisis when they made a killing on subprime mortgages) are an object lesson in the importance of risk-adjusted returns and avoiding chasing celebrity managers and what we in the business call “hot dots.” The sad reality is that few fund managers have demonstrated an ability to make money without the Fed pumping huge amounts of liquidity into the market, suggesting that as the Fed moves closer to raising rates again returns are likely to be even worse.
See you on the other side.