When this doesn't happen tomorrow, can we once and for all quit talking about recessions, crashes, and general market malaise? - Okie 'The Nightmare Begins Wednesday Morning'Nov. 7, 2016 11:26 PM ET
David Pinsen
Summary
Last week, we asked who was afraid of a Trump victory. Futures markets answered that question Sunday night, as they rallied on news the FBI reclosed its email investigation.
The party continued on Monday, as market fears of a Trump victory receded. But former Reagan administration OMB director David Stockman thought that reaction was wrong.
Stockman argued on Bloomberg that the nightmare would begin on Wednesday. We lay out his thinking and present an updated hedge against market risk.
Photo via Bloomberg TV.
Who Is Afraid Of Trump Winning?Last week, we asked who is afraid of Trump winning. On Sunday night, we got our answer, as stock futures jumped and gold dropped on the news that FBI Director James Comey announced that he had reclosed the investigation into Hillary Clinton's emails. Markets followed suit on Monday, as investors' concerns about a Donald Trump victory on Tuesday receded (most national polls shared the markets' view, with a couple of notable exceptions: the LA Times/USC poll, and the Investor's Business Daily/TIPP Poll).
But portfolio manager Eddy Elfenbein wondered if markets were worried about the wrong thing:
Screen capture via Twitter.
And one event most investors don't seem to be afraid of is Hillary Clinton winning the election. David Stockman, who headed the United States Office of Management and Budget under President Reagan, is an exception in that regard. On Bloomberg TV's What'd You Miss on Monday, he argued that the stock market was due for a reckoning regardless of who wins the election:
David Stockman:
"If we need any proof that there are only idiots and robo-machines left on Wall Street, look at the market today. We're on the cusp of a breakdown in governance. If Trump happens to win because of a Brexit effect -- and I know you talked it down last time, but it's possible -- there will be unmitigated disaster in Washington. If Hillary wins, the election recount will start the next day. And I don't mean recount argued about Nevada, I mean the House will be controlled by Republicans, there will be ten committees holding investigations with subpoena power, we haven't even gotten to the beginning of what's going to come out of the FBI and the Justice Department, and Wikileaks and the Clinton Foundation and the rest of it. Government will be froze for at least a year, if I can say that, and in that year there will be no fiscal handoff, which the market expects today, a handoff from monetary policy which is out of dry powder. It won't happen, there will not be a debt ceiling increase which we desperately need, over the $20 trillion mark in March, there will be a huge political standoff, or showdown on that, I think it will spook the markets like never before, they're overvalued, and they'll crash."
Joe Wiesenthal:
"So, basically what you're saying is all of us have [been] like, 'finally, the election is almost over,' one more day until the long national nightmare comes to an end. The fundamental forces at play here that we're seeing, breakdown in the institutions, breakdown in the power of the parties, breakdown in certain norms of politics -- we're just getting started with that?"
David Stockman:
"Yeah, I would say that the nightmare starts Wednesday morning. I happen to around long enough that I was there in '73 and '74 for Watergate. I remember when the acrimony reached a pitch. Government did shut down. It did freeze."
Here's a look at how the S&P 500 did during that time period:
Screen capture via YCharts
Not Too Late To Hedge Market RiskIn our previous article ("Who's Afraid Of Donald Trump Winning?"), we presented a step-by-step guide to hedging a $1 million portfolio against market risk by buying optimal puts on the SPDR S&P 500 ETF (NYSEARCA:SPY). Most of the 250+ comments on that article dealt with the political and economic implications of the election, but one commenter suggested it was too late to hedge market risk.
That wasn't true last week, as the cost of protection against a greater than 20% drop out to June was only about 1.35% of position value, calculated conservative. And it wasn't the case on Monday either. Running the numbers again, via the Portfolio Armor iOS app, these were the optimal puts using similar parameters as of Monday's close:
As you can see above, the cost of this hedge was $13,348, or 1.33% of portfolio value (using ~$1 million of SPY shares as a proxy). A couple of notes about this hedge:
As was the case last time, it was calculated conservatively, using the ask price of the put options. In practice, you can often buy put options for less, so you would likely have been able to buy these puts for less on Monday.
Unlike last time, it was cheaper this time to round up the number of shares to the next highest round lot and hedge it. $1 million worth of SPY was about 4,692 shares on Monday, but it was cheaper to hedge 4,700 shares against a 20% drop, as we did above.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.