Quick Take On Presidential Inauguration

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Next week's presidential inauguration is a much-awaited phenomenon - for general public as well as for the financial markets across the globe. Dow 20K is mostly an arbitrary mark for a market index designed for pre-computer era (and some equally arbitrary Theoretical Dow has already crossed the benchmark). But it appears the entire market is somewhat directionless at present. Since the election, it has made certain assumptions on the policies of the upcoming government and has shown some very strong move across asset classes (see here, here and here). However, we still have very little in terms of concrete policy direction to rely upon. The latest press conference did not quite live up to the expectation of details on policies. Strong guidelines on future policy in the inauguration can provide a new direction to the market one way or the other. And this can kick-start the next phase in the market.

The charts below show the market impact of presidential inauguration since the post-war era (excluding the first term of Barack Obama, which was, in many ways, an outlier). The X-axis is the number of business days from the inauguration day. The chart on the right shows normalized moves of the S&P 500 Index from three months before to three months after for each inauguration. The chart on the left shows the median line and the uncertainty around it. It appears more often than not, the markets usually rally into the inauguration, experience a slight correction going into the exact date, and top out around one or two weeks after the actual date before picking up its own course. (Note we have not corrected for the usually positive trends for the markets in general, and hence, we should not focus much on the trends here but change in the direction of the trends instead.) However, we have quite an amount of uncertainties around this. Looking closely at the right hand side chart, we see this pattern was more or less followed by around 10 or 11 times out of last 17 cases. (The legends on the right chart are initials of the presidents followed by a digit signifying the term, if required.)

Overall, positioning-wise, we have nothing extreme in either way. Post-elections, the leveraged funds (CTAs and hedge funds) and asset managers have increased their long (from CFTC reports). The dealers have become slightly short the markets - but all well within range. On VIX, however, the dealers and asset managers remain long against the leveraged players.

This and trend analysis of the recent intraday movement of S&P 500 suggest the street (i.e. the players who hedge) is mostly long gamma at this point. See the chart below. This means a large sell-off is quite unlikely in the short term. On top of this, we have the asymmetric scenario on the policy clarity. If President-elect Trump does announce clear guidelines on his policies, this will likely confirm the market assumptions (very low chance of a major negative surprise) and the market can have the next leg of the rally. On the other hand, the impact of rhetorics and vagueness will most likely be muted as there is always the next time. This suggests a long positioning for the equities. However, the case of dollar is quite different. We have a very strong long dollar positioning from the leveraged players and any disappointment can be felt quite hard in the dollar.

Finally, while you can't miss the obvious market reaction to Trump's win, it is fairly easy to miss - what I think the most dramatic - real economy reaction. The NFIB small business optimism and outlook went over the top following the election, much more than the overall business outlook and optimism measures. The charts show the standardized measure and the spread.

I think in itself, this is quite significant. Historically, we have only two similar situations when the business indicators were significantly positive and small business optimism outperformed overall measures. Once was during the recovery of the early 1990s and secondly, during the recovery of the early 2000s. While we have too few data points to draw any statistical conclusion, in both cases, we had sustained economic improvement and overall positive market performance. Of course, small business optimism does not necessarily mean it will be realized, nor what is good for small businesses is also necessarily good for overall markets. But perhaps we have too many people bracing for a crash now?

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