February 16, 2016
• Uncertainty with a capital U
• Two primaries down and a foggy out-look
• The Bloomberg factor
• Outsiders bring some radical ideas
• Cash is the best bet
Seeking Alpha would not publish this piece; perhaps it was not “politically correct”. Perhaps they want to avoid politics at all cost. Problem is, the markets these days may just be a reflection of politics and that is likely to be the case as the U.S. election nears. When it comes to political correctness, we can all learn valuable lessons from Triumph — The Comic Insult .
Change is inevitable in life. Change creates excitement and appeals to our adventurous spirits. We change throughout our lives and the environment that we live in is constantly changing. Technology has increased the pace of change over recent years. Change occurs on a global basis, within our nation and individually.
I have been observing the current Presidential election process in the United States with keen interest. This is the fourteenth of my lifetime. My journey through this life has spanned 56 years and eleven Presidents. Six of those sat in the office for two terms. The President of the United States is the most powerful leader in the world from both a military and economic perspective. The passing of the baton from one President is a process that involves change. We get used to Presidents over their terms. Whether we support the sitting leader or not, the vast majority of Americans respect the office and power of the position. Therefore, the changing of the leadership of the U.S. is an important event, a change that occurs according to schedule each four or eight years.
In history, sometimes events transpire that cause the change in occupants of the White House in a flash. The assassination of John F. Kennedy, the resignation of Richard M. Nixon or other events over history have brought change to the leadership of the nation overnight. However, the normal cycle promotes a long and cathartic process of selecting the next leader of the nation.
The process itself gives the populous two things. First, it provides the opportunity to select from candidates in a process that defines our democracy itself. Second, it gives us all the opportunity to prepare for change in three steps. In step one the candidates make their case. In these modern times, media inundates those of us who wish to follow the process. We can do so on a twenty-four-hour-per-day, seven-day-a-week basis. Step two involves a primary process, which narrows down the candidates, generally to two — one democrat and one republican. Step two culminates in conventions for each party, which kicks off the general election.
Step three pits the two candidates against one and other and in November the people vote to elect one person to lead the nation. With great pomp and circumstance, we inaugurate the new leader in January of the following year. The reason that I have spelled out the process is that each step is a catharsis, a process that prepares us for change.
While change is exciting, it also creates anxiety and fear. After all, the status quo is the essence of stability and change represents uncertainty.
Uncertainty with a capital U
My friend and colleague, Dr. Yosef Bonaparte is an Assistant Professor of Finance at the Business School of the University of Colorado, Denver. Yosef does a great deal of work and research in the area of behavioral finance. In his recent work, he has documented and explained the increase in volatility in U.S. equity markets during periods when one Presidential term ends and another begins.
Professor Bonaparte’s work is self-explanatory. The bottom line is that volatility in equity markets historically precedes changes in administrations. Stock market action during Presidential years is not just about data, it is about investor behavior. While this makes good intuitive sense, I would make the case that the current election cycle is very different from others in my lifetime.
Two primaries down and a foggy out-look
The current election process began back in the summer with a slew of candidates and copious news coverage. We have seen debates, town hall meetings, speeches and interviews over recent months all leading up to the selection, the narrowing down process. As I write this article, I sit here digesting the results of the New Hampshire primary and Iowa caucuses for both parties. We now have real election data for the first time in this election cycle — polls are one thing but when the people speak with their votes, we can begin to understand the current political temperature in the nation.
We can make many observations about the current process. So far, participation rates in both Iowa and New Hampshire are at record levels for both political parties. This tells us that people are participating in the process because they have issues they want addressed. The results of the first two election events in the primary process also tells us that while we are a divided nation in terms of republicans and democrats, there are vast divisions within the parties themselves.
The top polling republican candidates include senators, governors and a businessman who just happens to be a media star as well. After Iowa and New Hampshire, Donald Trump has the most delegates to the convention. A true outsider, Trump represents a desire by the majority of voters who have spoken to change the status quo. Mr. Trump admits that his message is populist and positive, to make America great again. Ted Cruz, the candidate with the second most delegates at this time, is a senator however; he is a politician who is not a party favorite according to many mainstream republicans. Therefore, Cruz represents an outside-insider and a repudiation of politics as usual in Washington D.C. To me as an observer, it seems the status quo in the Republican Party is not comfortable with neither Trump nor Cruz.
On the other side of the political aisle, the situation is equally interesting. It was almost a foregone conclusion that Hillary Clinton would breeze through the primary process with little or no opposition within her party. When a senator from Vermont announced his candidacy, few took notice. After all, the senator has defined himself as a socialist and an independent. On the political spectrum, Bernie Sanders takes pride in being consistently left of the most liberal democrats. Besides, Vermont is such a small state that it has two senators and only one congressional representative suggesting that Sander’s political base was limited. Clinton, as a former first lady, senator from the state of New York, and Secretary of State had both name recognition and a ubiquitous political base.
A funny thing happened on the way to the first two democratic primaries; Sanders seems to have hit a nerve with many democrats. In Iowa, he finished uncomfortably close to Clinton — only 0.3% of the vote separated the two. In New Hampshire, Sanders blew Clinton away, winning the primary by over 22%. While the state borders Sander’s home state, the self-proclaimed “democratic socialist” senator’s message must have resonated with voters — young, old, women and men alike in New Hampshire. Redistribution of wealth, the vilification of Wall Street and banks and his overall social platform drew votes from Clinton.
As the candidates now head to South Carolina and Nevada, the races are shaping up as what looks to be party establishment versus those who propose change from the outside. So far, the outsiders are blowing away the insiders and that tells us something about the current political and economic environment in the U.S.
The Bloomberg factor
As Trump and Sanders, two real outsiders self-admittedly each with some radical ideas, now have the most delegates in their respective parties, the potential for a third party candidate has increased. Michael Bloomberg, the moderate former Mayor of New York City and billionaire recently said he is considering a run. In a recent interview Bloomberg said, “I find the level of discourse and discussion distressingly banal and an outrage and an insult to the voters.” — He added that the public deserves “a lot better” than the current slate of candidates.
While Bloomberg was a Republican mayor of NYC, he is a fiscal conservative and a liberal on social issues and gun control. While Trump is rich and self-funding his own campaign, Bloomberg has even more money with a net worth of around $39 billion. The entrance of Bloomberg into the political fray would result in even more uncertainty, although it would raise the entertainment level of the election to a new level.
Outsiders bring some radical ideas
The two men who currently hold the most delegates in their respective parties provide a clear and distinct contrast and represent the divisions within the nation.
Bernie Sanders has attacked financial institutions in his campaign message. He represents a common notion amongst many Americans that banks and Wall Street companies have figured out a way to privatize profits and socialize losses since the financial crisis of 2008. Sanders promises to change this in a way that would benefit the masses in a message that has been very attractive to voters. This 74-year-old candidate has invigorated young voters who have flocked to his campaign. At the very least, Sander’s will push Clinton who remains the favorite far to the left. On the other hand, he could wind up being the nominee.
Donald Trump, the real estate mogul, has virtually no filter. He does not deliver prepared speeches, he does not use a teleprompter and he is politically incorrect on a daily basis. He is also brilliant at using social media like twitter and other vehicles to get his message out on a minute-to-minute basis. He is not afraid to take on other candidates. He appeals to his voters with his message of building a wall on the U.S. border with Mexico and making the Mexican government pay for it. Many voters likely look to his personal success as a sign that the businessman has the management skills and persona to lead the nation and the world. Interestingly, Trump is self-funding and the richest candidate in either party right now. He has done the best in terms of the first two elections this primary season. At the same time, he has spent very little money. Trump’s personality is such that he is a constant subject of the media. He picks fights with them, says outrageous things and people all over the country want to know, what did he say last? In a brilliant move, Trump has been able to use free media to get his name and message out and almost monopolize the airwaves on a consistent basis.
The bottom line right now is that we have a Presidential election process where the leaders represent extremes in both parties. If you look up the word capitalist in the dictionary, the definition could be a picture of Trump. If you look up the term socialist, Sanders would represent the classic definition. This says a great deal about the voting population and their desire for the future direction of the nation. It also represents a very clear and distinct choice.
Cash is the best bet
This election is perhaps the most controversial in the modern day history of the United States. The democrats have moved left in a big way and the republicans have moved far right. This tells us that a big change is coming in the United States and right now, we do not know which way this will all shake out. This is the essence of uncertainty.
When it comes to markets, across all asset classes, this is a prescription for huge and even unprecedented volatility. That is exactly what we are seeing in equity, debt, currency and commodity markets so far in 2016. The chances are that we will see a lot more in the months ahead. As far as equities are concerned, this is not the time to step up and buy. Dr. Bonaparte’s work tells us those lame duck years for a sitting President tend to be volatile. Given the level of uncertainty that awaits in the process to succeed the current administration, the best option for investors is to remain in cash.
The Carden Smart Hedge™ Index systematic signal switched to cash on December 11, 2015 when the S&P 500 index was trading at 2,012.37. On Friday, February 12 just two months later, the S&P 500 closed at 1,860 — a decrease of 7.6%. The index remains in cash and volatile market conditions promise to remain until certainty and stability returns in terms of the current political environment in the United States. The way this election season is shaping up; it is just more bad news for stocks.
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