@theMarket: Will Election Fears Trigger More Downside

Tuesday's presidential elections and the Fed's decision on interest rates have traders rushing to hedge their portfolios or go to cash. It is a little late in the day to take such action.

 

Over the last few weeks, I have been warning readers that the days surrounding the election could prove to be volatile. That situation appears to be taking center stage as we close this week's trading. I also urged investors not to get caught up in the panic and I hope you listened.

 

We are no further along in predicting the election outcomes than last month. The only thing we do know is that the race is too tight to call, and the popular vote will not be a determining factor in the results. The Electoral College will call the shots, so it comes down to the individual states.

 

The consensus on Wall Street is that the U.S. Senate has a high probability of going Republican.  The House is a toss-up. What party gains the majority will depend on whoever wins the presidency. The betting markets have Trump's probability of winning at 63 percent. The polls say it is a dead heat.

 

We may not know who won the race by Tuesday night. It could even take a day or two before there is a definitive result. Congressional winners might take longer than that since some states like California and New York have been notoriously slow in counting ballots in years past. It is fair to assume a period of recounts and legal challenges.

 

That means there may be a period where the country (and markets) will be in limbo. You may remember the Busch-Gore election of 2000 where the election results were contested by Al Gore. It wasn't until Dec. 12, 2000, that the election was decided. The S&P 500 Index fell 8 percent during that month. 

 

Historically, investors have difficulty dealing with the unknown and this time should be no different. That could mean a couple more days if not more, of extreme volatility after the election.

 

On Thursday, the FOMC will announce its interest rate decision. The bond traders expect a 25-basis point reduction in the Fed funds rate. The odds, however, of another cut in December have come way down over the last month.

 

This week's deluge of data paints a picture of a strong economy with third-quarter GDP estimated to be 2.8 percent, slightly down from last quarter's 2.9 percent pace. The most recent update on inflation, the Personal Consumer Expenditures data rose 2.1 percent last month, which was within the range of estimates. But the Fed likes to look at the "core" PCE, which excludes food and energy. On that metric inflation is at the same level it was In August showing no improvement.

 

If you look at the inflation data in a different way, it may help you to understand why many voters are unhappy with the state of the economy.  When you divide the inflation rate into discretionary items (eating out, movies, concerts, trips, etc.) versus non-discretionary items (food, fuel, health care, insurance) there is a glaring disconnect between the two. The discretionary inflation rate is down to almost 1 percent growth, but non-discretionary is greater than 5 percent. It shows that lower-income voters, who can only afford the basics, are still getting walloped by inflation.  

 

The non-farm payroll report for October was a big surprise, adding just 12,000 jobs. However, the markets are discounting that number due to the labor disruptions caused by two hurricanes plus strikes at Boeing. In summary, the macroeconomic data reported this week should keep the Fed on track to cut interest rates by another quarter percent next week. As for their plans for future cuts, I expect the Fed will remain data dependent.

 

In the days ahead, financial market volatility should increase. Markets will move quickly on the events as they unfold. I would not be surprised to see a minus-1.9 percent down day, for example, followed by a plus-2 percent up day, followed by another down minus-1 percent day. That is because the short-term movements of the markets are largely in the hands of algorithmic computers, proprietary traders, and ODTE options traders.  

 

Elections, especially this election, will not only impact financial markets but will also affect most people personally.  I get that, but my advice is to stay on the sidelines as far as your portfolios are concerned. Historically, just remember that elections have little to no impact on the market's performance after a few weeks.

 

Bill Schmick is the founding partner of Onota Partners, Inc., in the Berkshires. His forecasts and opinions are purely his own and do not necessarily represent the views of Onota Partners Inc. (OPI). None of his commentary is or should be considered investment advice. Direct your inquiries to Bill at 1-413-347-2401 or email him at bill@schmicksretiredinvestor.com.