Presidential Election Prompts Spike in Markets' 'Fear Index'

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Filbrandt
Nov 06, 2016

Spike in Markets Fear

The Chicago Board Options Exchange (CBOE) Volatility Index, also known as the “fear index” of U.S. markets, has jumped 65 percent in the past two weeks. This coincides with the gains Donald Trump made in the polls during that period. 

The last two times the Volatility Index reached these levels was amid the market turmoil that followed the depreciation of the Chinese yuan in August 2015, and ahead of the Brexit referendum in June. On Friday, November 4, the CBOE Volatility Index closed at its highest since Brexit.

The markets are notoriously wary of uncertainty, and political risk following the FBI's renewed probe into Hillary Clinton's emails has sparked growing concern over a potential Donald Trump presidency. The FBI announced over the weekend that their review of Clinton’s emails found nothing incriminating, resulting in a jump in stock prices Monday morning, the day before the election.

It seems clear that there will be volatility in the markets, due to fear and concern, no matter which candidate wins. On Friday, the S&P 500 Index suffered its ninth consecutive decline, its longest losing streak in 36 years. Analysts believe the decline reflects the market adjusting to an increased likelihood of a Trump victory. Its timeline matches the period since FBI Director James Comey announced that the investigation into Hillary Clinton’s emails would be reopened.

Ethan Harris, head of global economics at Bank of America Merrill Lynch, told CNBC he expects a market sell-off if Trump wins, then an L-shaped move in the equity market, because of the period of policy uncertainty. 

"From the action in the stock market, the equity market is worried about a Trump victory, about the uncertainty of policy under Trump. Normally the equity market responds positively to a Republican doing well in the election," he said. "In this election, I think the dominant story is about uncertainty after the election, and a status quo election means no shock, everything is the same, no big news and presumably the equity market sails through the election if it's a split government."

The expectation among investors has been that Clinton would win the presidency, while at least one house of Congress would remain in Republican control. In effect, it would mean status quo and therefore relatively little uncertainty. A Trump victory would bring much more uncertainty because it is not at all clear what kind of working relationship he would have with Congress, even if GOP-controlled. It is also not clear how many of his campaign pledges he will work hard to enact immediately or even in the longer term.

If you’re among those who think Trump can’t possibly win, remember back to 1998 when Jesse “The Body” Ventura, a television personality and pro wrestler, staged an amazing upset to become the governor of Minnesota as an independent candidate. His four-year term was largely characterized by dead-ends in working with the Legislature since he had no partisan delegation backing him. There was controversy over his outside earnings (book deals, on-air host for the new XFL pro football league), which may sound somewhat familiar.

Trump might as well be an independent because he has nowhere near a consensus of support in Congress among Republicans. It will be very interesting to see what sort of working relationship Trump has on Capitol Hill if he is elected.

On the other hand, it is fairly clear that Clinton will have staunch support among her Democratic colleagues – another reason why investors believe her election would bring much less uncertainty than Trump’s.

In either case, we recommend a level head. There is very little to be gained by joining a tidal wave of emotion. However the market reacts, it is not likely to be permanent.

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