Predicting the Unpredictable

How to Make Money out of Politics (Part 2)

A typical week in markets it seems. Politics remains at the forefront of a deteriorating global economy.

 

Trump was exonerated from collusion with Russia in the 2016 election. And steady progress was made on trade talks with China leading to a staggered recovery in Indices, despite another yet warning shot for the global economy. This time the surprisingly dovish central bank of New Zealand prompted a 1.5% drop in the Kiwi in 23 minutes, a move we caught and squared based on an exact copy of the RBNZ fractal and analogous to the February 6th AUD drop in response to a similar warning from the RBA. The dovish chorus is growing and getting louder creating much welcome increasing two way volatility. Similarly, incompetent central bank manipulation in Turkey created a 7% spike down and recovery then further collapse in the Turkish Lira.

 

But the story of the week was Brexit and the increasingly precarious position of the UK in its so far failed attempt to leave the European Union. Missing the March 29th deadline for Brexit was not, in the end, a shock. But the failure of UK markets so far to collapse, confronted by such uncertainty, is perhaps unexpected. Will traders be saying the same at the end of the next quarter or indeed 2019 as the reality of Brexit is upon us?

 

It is quite clear what is going on in the UK and indeed the world. The underlying fundamental outlook for the next year is getting worse almost by the day. Yet markets are choosing to ignore this. They are buoyed more by an optimistic sentiment about agreements (Brexit/Trade War) that could but won’t save the day. These agreements are unlikely to prevent the damage already done from hitting markets later.

 

Its like a climbing a hill, fighting off the fatigue and all the uncertain variable elements, determined to get to the summit. Different climbers will reach the top at different times but once they are there, there is only one direction.

 

The issue is not just how and when individual markets will reach the top but how can we exploit politics and market sentiment in the interim. If you excuse the mixed metaphor: Bread today, guns tomorrow.

 

This week’s Newsletter focuses on three such political opportunities (Britain, India and Australia) that may now all have something in common: an election.

 

The market’s approach to the UK’s exit from the European Union is very much tied into politicians, commentators and the average UK citizens view of Brexit. Fatigued, uncertain, sometimes embarrassed but desperate for a positive resolution as soon as possible. It’s been a very long uphill struggle. In our Brexit blog and previous newsletters we have explained how uncertainty about uncertainty has combined with optimism about a deal to keep Sterling, FTSE and, in our opinion, the key yield curve (the true Brexit barometer) stable to strong.

 

As comparison to the early stages in the UK 2/10 spread rally demonstrates the recent optimism (about an orderly Brexit compared to a seemingly disastrous no deal Brexit) is dented at this point before leading to even greater optimism into the deal or the actual UK exit from the EU. At which point the reality of Brexit, the investment gap created by years of uncertainty and the now global distrust about the UK government’s ability to manage a post Brexit environment, should come together and severely impact the UK economy and markets—even if only for a relatively short period.

 

How we trade this is guided by short term cynicism about news events (sentiment) and  technical comparisons (eg NZDUSD) that have helped secure 526 GBPUSD pips (4%) in the last month. But also now the probability of Theresa May’s resignation, even a No Deal outcome and the prospect of a general election has been raised, we can monitor how both GBPUSD and FTSE’s trade compared to previous historical election performances.

 

The match to 50 days before an election is perhaps surprising but also exciting. Of course, it may not be an election but another significant event such as Brexit itself. This not only increases the probability of our buy the rumour sell the fact view of a Brexit deal but provides us with a guide to the timing of potentially very lucrative trades. For now buying GBPUSD spike-downs buying EURGBP around the targeted ‘election day’ for the Sterling dump and later buying GBPUSD for the trade war inspired USD downtrend and post Brexit dump recovery.

 

INDIA
The outlook for the forthcoming Indian election is similarly uncertain. The somewhat complex Indian General Election will be held from 11 April-19 May 2019 with the counting and declaration on 23 May. The long period of voting will of course allow a degree of speculation as to the result from exit polls.

 

The ruling National Democratic Alliance (NDA) which is a stable centre-right coalition led by PM Modi’s BJP has led the polls consistently, although their estimated share of the vote has fallen in the last 12 months from 38.5% to about 34%.

 

The centre-left United Progressive Alliance (UPA) grouping, primarily the Indian Congress Party led by Rahul Gandhi is the next largest party, and has been beating the BJP in state elections. (India has a federal system like the US). However a third of seats are expected to go to smaller parties.

 

The opposition have campaigned on various issues remarkably similar to the US and Europe, the undermining of institutions by Modi, neglect of regional development, granting citizenship to non-ethnic Indian minorities, unemployment and of course corruption. They have also sought to exploit growing disappointment that Modi has failed to deliver on his fabulous 2014 promises.

 

So how does a general election affect the Indian stock market? History has a clear answer.

 

In the context of a persistent global (but arguably unjustifiable) uptrend, finding real reasons to buy stocks provides greater probability and confidence. Our trading strategy and already issued trading signals is still to buy (Mo)dips.

 

However, the state elections in December 2018 showed a shift away from the BJP and the NIFTY index dropped 2% showing that the election and Nifty outcome is far less certain.

 

A BJP win (like Republicans in the US or Conservatives in the UK) is the best result for the market, and should result in a further rally. Any other result (ie BJP winning less than 272 of the 543 seats) leads to a hung parliament which seems an increasingly likely result. But it depends how hung. The Indian Congress Party would need to widen their coalition beyond the UPA to encompass enough minor parties to form a working government, the degree of UPA victory determining how far they had to reach. But anything other than an NDA (BJP) win mean uncertainty, resulting in a sharp initial drop, followed by heightened volatility. An outcome which does not move the markets seems unlikely.

 

The analogy with UK political-stock market can be taken one step further. Nifty is currently following a UK hung parliament template.

 

Although the general run up to the election is similar for both a BJP majority and hung parliament, the difference just before the election is quite stark and should help tip the outcome and in particularly our trading strategy thereafter.

 

AUSTRALIA
The political and therefore market outcome for the forthcoming Australian elections is far more certain (or better, less uncertain) than either the UK or India.

 

The Australian Federal Election must be held on or before May 18 this year. Australia is bicameral with 226 representatives and 76 senators and is dominated by the two major parties. The centre-right Liberal/National Party Coalition (L/NP) currently rule with a small majority of 4 in the House and 5 in the Senate over the opposition centre-left Australian Labor Party (ALP). However there are 8 ‘crossbenchers’ in the House and 19 in the Senate (including 9 Greens, effectively ALP votes in opposition) making government shaky at best.

 

Although little love is lost between voters and leaders Morrison (L/NP) and Shorten (ALP), most commentators are tipping the ALP will win the election and bookmakers are predicting a 17-seat ALP majority. Historically, because of the dominance of the two major parties, a hung parliament is unlikely.

 

What does this mean for markets?

 

The Australian stock market typically stabilises before the election but then rallies after..with the exception of 1996 and 2007.

 

Given the prospect of a Labour victory and the associated and promised fiscal expansion the impact is likely to be accentuated.

 

However, of more concern to us, is the effect on the Australian Dollar particularly in the context of an uncertain (but we believe bearish) post-protectionist USD environment. The impact of a labour victory and subsequently inflation on AUDUSD is significant.

 

As a consequence, we have started implementing a staggered buying strategy into the Australian election, initially with June calls but looking to buy cash when the technical/sentiment outlooks provide the greatest return-risk set up.

 

Do we need to predictable the unpredictable? Yes and No.

 

It is a well known aphorism that markets hate uncertainty. And there is little more uncertain in politics than an election. But when politics is so volatile, where the uncertainty is uncertain, markets have a habit of actually going nowhere fast ie directionless. These political environments provide great range or drift trading opportunities which provide some excellent trades on a day to day basis. It is only when the uncertainty (about the uncertainty) dies down as we approach a major event such as Brexit or an election that volatility picks up typically one direction and in trend lasting weeks. We are confident about how we can exploit both types of market volatility in the coming weeks even if the political outcomes remain uncertain.

 

Here’s to making the very best.

Good Luck

 

 

 

Ed Matts
Founder
Matrix Trade

 

To receive our weekly articles by email in advance of publication, please sign up for our Sunday newsletter.