'Brump' or 'Trexit'? Markets may conflate year's biggest risks
Published 08/06/2016 | 07:45
Even though market myopia is often used to explain why investors appear to be ignoring November's U.S. presidential election while trading furiously around this month's vote on Britain leaving the EU, the two events may end up being conflated.
Fund managers and economists, including Harvard professor and Democrat grandee Lawrence Summers, puzzle endlessly as to why UK and European markets are gyrating ahead of the "Brexit" vote but US assets have barely blinked at the success of celebrity businessman Donald Trump's bid for the White House.
Volatility surrounding a possible redefinition of Britain's dominant trade and political relationship is relatively easy to understand. It's not only about how the potential hiatus affects the UK economy but also how wider European and euro zone markets are likely to suffer from uncertainty over the future of the EU integration itself.
Britain may be the world's fifth largest economy but the combined economic output of the EU is 22 percent of global gross domestic product, according to International Monetary Fund data.
Many argue Republican Trump's proposals for reshaping the trade and diplomatic relations of the world's largest economy, his anti-immigration policies and his questions about US Treasury obligations create at least as much market uncertainty as the Brexit referendum.
Bookmakers and prediction markets see neither a vote for Brexit nor a Trump win as the most likely outcome. But they do ascribe a similar probability to both results: roughly a one-in-three chance that markets would typically take seriously but have done so only in one of the instances this time around.
While sterling, sterling options, UK housebuilding stocks and even government bonds from countries on the euro zone periphery have juddered back and forth for months, there has been no perceptible jolt to date for the US dollar or its derivatives, Treasury bond prices or Wall Street stocks from the White House election race.
Quite the contrary. The S&P500 index of top US companies hit its highest levels for almost a year this week and the VIX index, or "fear gauge", of implied volatility on the benchmark S&P remains sedate near its lowest levels of 2016.
"The markets tend to ignore political risk, which generally has little influence over the real economy. But maybe they should be concerned this time," Didier Saint-Georges, managing director at French asset manager Carmignac, said.
"Almost inconceivable six months ago, the election by the end of the year of an openly protectionist president inclined to renegotiate federal debt is now plausible in the United States."
Despite this anxiety, investors variously explain the lack of election-related volatility by saying markets tend to focus on one thing at a time or that November is simply too far away.
However, that wasn't true of market thinking on Brexit.
As far back as December, the cost of six-month sterling options expiring just after the expected June voting date spiked. No such surge was seen in six-month dollar volatility even though it crossed the November election date last month.
Bank of America Merrill's May global funds survey did show US politics well behind Brexit and a China devaluation as leftfield worries for 2016. Still, the net number of funds citing the presidential election as a concern doubled over the previous month and it was ranked as the No. 4 "tail risk" of the year.
So what gives?
Many think the policies of any Trump administration would be less radical than his pronouncements on the hustings and others say the checks and balances of the US political system would limit his impact.
There is also the idea a Trump victory and its implications for world trade would hit global assets equally and US markets per se have not been singled out or shunned as a result.
"Brexit is a bigger risk," Francois Perol, Chairman of France's second biggest lender BPCE, said last week. "American democracy has strong institutions and counter-powers."
Perol said Brexit raised serious questions about EU and euro zone integrity and he was "not sure whether the political response is ready".
But he did moot the idea that the two issues could be connected and that the June 23 vote was conflating in market psyches. "It is maybe that Brexit would increase the chance of Trump winning somehow," he said.
And a win for advocates of Brexit - or indeed a narrow defeat that keeps the issue on the boil across Europe - may well require investors to reassess the electoral clout of disaffected voters on both sides of the Atlantic and bring November's election squarely onto market radars.
Both campaigns thrive on voter dissatisfaction with the status quo and the political middle ground. Both are rooted in the recent banking and economic crises and have similar manifestations in many Western countries even in the face of tepid recoveries.
A confluence is perhaps what markets fear most.
A win for both camps, by accident or design, could deal a protracted blow to global trade and the blue-chip equity of multi-national corporations across the planet that thrive off smooth cross-border movement of goods.
This "quality" equity has been a massive draw for risk-averse investment since the 2007/2008 crash and the shock of a win for Brexit and Trump could be big.
And together the United States and European Union are almost 50 percent of world GDP and global stock market capitalization.