Political Impact

The Knock Out or Knock In Blow? – Trading Political Impact

In a week that saw the mid-term elections come in exactly as expected, and then FOMC say exactly what was expected, many markets remained nervous and subject to the projected 2 way volatility but not what many expected.. either way. There were however notable exceptions. Oil posted a second week of five red candles, and formally entered bear territory, having dropped over 20% in a month. Much of this general market movement can be attributed to the liquidation of positions (both investment and hedges) as a result of events that were expected but over-anticipated: Continued Fed tightening towards a neutral position, earnings that proved to be one of the strongest seasons in a decade, and US mid term elections that resulted in a split Congress.

In over 25 years of trading markets, I cannot recall such a news or event driven market. That doesn’t mean there hasn’t been one. Simply that as traders we are more focused on the current and tend to forget the impact of news during arguably more significant episodes. But, in many instances, how markets reacted then, and arguably more recently to Trump events, holds the key to how they are reacting now and in future.

The personalities, often the countries, the sequences, many of the details involved in any one series of events or the prevailing conditions will be different to another. But as the decisions of traders or investors can be reasonably distilled into buy or sell or stay out, the various ways markets react to these different events are far more limited can frequently be compared. Can they all be compared?

In the context of a long term global stock uptrend, the anticipation or nervousness into an event will frequently slow the trend.

And the event itself will often prompt a retracement – the classic buy the rumor sell the fact. But this is on average and glosses over the extent to which the market may have positioned in front of the event as we saw recently with significant buying and subsequent liquidation before US earnings releases – even though the earnings seasons proved to be one of the strongest in a decade. But such averages therefore also ignore the underlying conditions or fundamentals that will determine the scale duration and context of the retracement.

Following our series of articles on how to trade news, the impact of Fed tightening into the US earnings season and this week’s mid term elections.. all in the context of a trade war a brewing Italian crisis and a prolonged Brexit saga, this week’s newsletter seeks to put trading such political events into context.

What is perhaps so unusual about the current market and makes it seem so different is the personalised nature of many events. Since Donald Trump’s election he has pursued a forthright agenda: tax cuts and fiscal expansion all in the context of a relative easy monetary policy. The consequent expectation of inflationary growth due to a business friendly agenda in the first year of the Trump presidency led to a rampant stock market a strong dollar that propelled global markets higher. Although economic growth and inflation have increased the expectation has exceeded reality as evidenced by historically extreme PE ratios in an economy that is near or at full capacity and reflected by companies seeking to expand through share purchases rather than real investment.

November looks set to be the strongest month on record for corporate stock buy backs ..as we have previously pointed out.. a feature in the latter stages of many bull markets. The parallels to the economic and market euphoria in 1929 and 1987 are well documented. But less so the underlying deterioration that also occurred in both periods due primarily to political events that are also comparable: a trade war, mounting political tension both abroad and domestically with respect to the Fed and US monetary policy. No one can be in any doubt about the President’s displeasure at continued Fed rate rises, not to mention balance sheet reduction (effectively the opposite of Quantitative Easing) as they jeopardise Trump’s expansionist programme. In retrospect many pundits, in our opinion wrongly, attributed October’s stock market rout to the growing tension between the Fed and the President over monetary policy.

October’s rout was caused more by investors and traders front-running widely expected strong earnings releases in a market that hadn’t fully factored in the impact of monetary tightening and the impact on yields and the Dollar. In other words, sentiment. As we have highlighted, the comparison to a similar tightening at the end of Quantitative Easing fits neatly with the amazing Nasdaq Calendar comparison between 2009-2014 with 2013 to date.

How then does this week’s US mid term election results affect this? Many believed anything short of a Republican victory in both Houses would cause a stock and USD sell off as it would undermine the President’s expansionist agenda and therefore Trumpflationary growth. And yet 2018 Trump is very different to 2017 Trump as the once business friendly President has pursued protectionist and regulatory polices that threaten economic growth in the longer term. Putting aside Donald Trump’s rhetoric before and after the midterms, a split house result possibly serves as a brake on these policies and possibly produce a positive result – the final stock blowout that history suggests could come on an easing of international tension.

How does this fit with Fed tightening? History has an Amazon answer.. the same.

The market also reacted in a similar fashion to how it normally does to both mid terms and FOMC.. which are surprisingly also alikeThe market also reacted in a similar fashion to how it normally and similarly reacts to both mid terms and FOMC.

This suggests this week could well produce an excellent opportunity in both indices and forex markets in the run up to the Thanksgiving-Xmas market.

Here’s to making the very best.

Good Luck

Ed Matts
Matrix Trade

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