Stocktake: Should investors sell if Trump wins?

There's been much chatter about how financial markets would respond to a Donald Trump victory in today's presidential election. However, a related question is rarely asked – should investors react to a Trump win?

Regarding the first question, StockTake agrees with the consensus argument that a Trump win would be a big negative for stocks. Markets are waking up to the risks, falling nine days in a row following the narrowing of Hillary Clinton's lead. However, a Trump win is not priced in – the daily declines were minor in nature and stocks remain close to all-time highs, so heavy market falls would not be surprising.

Additionally, there may well be sizable long-term as well as short-term consequences, given Trump’s dangerous economic nationalism and the obvious potential for geopolitical tensions arising from his thin-skinned narcissism.

None of this means investors should change course, however. Firstly, markets are unpredictable, as evidenced by the counter-intuitive post-Brexit rebound. Secondly, if you go to cash, when do you get back in? Do you devise an entry and exit plan for other risky events, whether they be European elections, banking crashes or regional wars? Where do you stop with this helter-skelter approach?

Doing so will hurt your wallet and shred your nerves. Long-term equity investors are rewarded for taking risk, not for abandoning ship when trouble hits. Markets are right to be scared about the prospect of President Trump, but ordinary investors with a long-term horizon should sit tight.

Clinton win should boost stocks

Betting on a Hillary Clinton victory, like betting on the Remain side to prevail during the Brexit referendum, is an asymmetric bet – that is, stocks are likely to lose much more from a Trump victory than they would gain from a Clinton win.

Nevertheless, the downturn in investor sentiment indicates there is potential for a short-term stock market pop. Equity managed funds recently suffered their biggest weekly outflow in five years. Cash levels among fund managers have spiked higher, reflecting investor nervousness.

Bullish sentiment among ordinary investors, as measured by the weekly American Association of Individual Investors poll, is at its lowest level since Brexit and has been below 30 per cent for 10 consecutive weeks – the second-longest streak in history, behind the 12-week streak that climaxed during February’s market bottom.

The Investors' Intelligence survey which tracks sentiment among newsletter writers last week hit its lowest levels since Brexit, a finding confirmed by MarketWatch's Mark Hulbert, whose Hulbert Nasdaq Newsletter Sentiment Index shows many market-timers have "turned cautious, if not outright bearish".

Last week’s market anxiety following the increased closeness of the presidential race means markets are less complacent about a Clinton victory and will surely breathe a sigh of relief should they get their desired scenario – a Democrat presidency and a Republican congress that represents continued political gridlock.

Hoping for some seasonal strength

Market anxiety may be rising but seasonal investors will be hoping stocks stick to the historical script and outperform in the coming months.

Historically, almost all market gains have occurred between November and April. Since 1950, $10,000 (€9k) invested in the Dow Jones Industrial Average would have compounded to over $1.1 million (€1m) over the November-April period, compared to around $13,000 (€11.7k) between May and October. The coming months tend to be particularly good – November has been the second-best month; December has been the top performer.

November has begun poorly, with stocks last week falling below their October lows. However, LPL Research strategist Ryan Detrick notes there have been only three occasions since 1970 when November ended the month below its October lows. December, he adds, has never once closed below its November lows.

In other words, stocks rarely stay low for long at this time of year.

Bad air, bad stock markets

Never mind the Trump effect on stocks, what about air pollution?

The authors of a new paper, The Effect of Air Pollution on Investor Behavior: Evidence from the S&P 500, tracked daily changes in fine particulate matter, which "easily enters buildings" and which has been found to impact brain health, cognition and risk attitude, over a 15-year period. Volatility was higher and returns 11.9 per cent lower on days when there was greater air pollution in Manhattan, the likely explanation being that sentiment was unconsciously dampened among Wall Street investors – higher pollution levels in other US cities were unrelated to stock returns, while stocks recovered in the days after the increase in New York pollution levels.

The findings are tentative, given that this is a working non-peer-reviewed paper, but a recent study of Chinese indices came to a similar conclusion, namely that investors “make worse trades on hazy days”.

See http://www.nber.org/papers/w22753.