The reason why I didn’t get caught up completely in the 9 day sell-off was because the market was falling for the wrong reasons. Based on my work, I think earnings won’t recover in 2017 and the economy will continue weakening. The market has been ignoring weak earnings and weak economic growth for a few quarters now. The 9 day decline continued that trend of ignoring reality as Trump’s odds of winning the election increasing was what caused it to fall.
Today the market is rallying about 2% as Hillary was cleared in the FBI investigation. If the market was fairly valued before it started to go down, then this rally makes sense, but since it is in a bubble, the rally shouldn’t be happening. If you are investing with a time horizon of 1 month, the election is very important, but if you aren’t, like me, then this is mainly short term noise.
I understand that the market is rallying because it was oversold and because Hillary’s odds increased. However, this entire rally will be reversed if Trump wins. My thoughts are the voting public is completely different from the market. While the market can form bubbles because of central bank policy, it does reflect new information immediately. The voting public does not reflect perfect information. Some voters won’t even know Hillary was cleared by the FBI. I don’t see how Hillary will gain millions of votes 3 days before the election because of this change. Because these swings are a few percentage points, the polls can’t accurately grasp what is going on in the swing voters’ minds. I challenge those who are buying stocks to find me a person who switched their vote based on this event.
According to the most accurate poll in the past 4 elections, the IBD/TIPP election tracking poll, Trump is winning by 2.4%. In the past 4 elections the poll has had an average error of 0.9%. Most polls have Hillary winning the national popular vote. I would normally ignore the two polls which have Trump winning, but when one of them is the most accurate poll at predicting elections, I can’t ignore it. On the website with the IBD/TIPP poll, it has the odds of who will win. Hillary is at 44%, Trump is at 24%, and Too Close is at 26%.
I think it’s reasonable to conclude based on the data we have at hand, that it would be foolish to make a directional bet on the market over the next two days. I explained why Trump could win, not because I think he will win, but because I think we don’t know who will win. The bulls have guts to make a big bet right before an event. Usually the market is flat the day before a big event such as a Fed meeting or jobs report. This time the market is making a big bet in one direction would will mean if Hillary wins, the rally will be small and if Trump wins the correction will be deep.
The market has essentially been flat for 2 years. It has been so flat that today’s rally is the equivalent to the past two years of increases in the market. I mentioned in the introduction that the market is ignoring the weakness in earnings. This is shown in the chart below. Seven out of eleven industries in the S$P 500 have experienced negative compound annual earnings growth rates from 2013-2016, yet the stock market has risen during that time frame. Analysts didn’t predict the market’s earnings decline which is why I don’t take their estimates for 2017 seriously. If the estimates are always up, then aren’t they simply a broken clock which is right during growth periods and wrong during slowdowns?
One of the bubbles in this economy which I haven’t talked about is the auto debt bubble. The Fed has created so many bubbles with ZIRP and QE it’s difficult to keep track. As you can see from the chart below, auto debt in the United States has reached new record highs. Some bulls have argued that the auto-loan bubble is manageable because it is smaller than the housing bubble, but they miss out on my argument. Just because it’s smaller doesn’t mean it doesn’t matter. Secondly bubble crashes are never manageable. Finally, because the whole economy is over-leveraged, so auto loans don’t have to be as big of a deal as housing to help crash the system.
The debt chart shows the fact that we are in a bubble, but it doesn’t show the timing of the burst. The total vehicle sales gives us a better picture of this. As you can see below, the current total is near the highs in the early 2000s. The blip at the end of the chart is being caused by record discounting. The average incentive in September was $3,932 per unit compared to the previous peak of $3,753 in December of 2008. As you can see from the chart below, vehicle sales were weak in December 2008, so heavy discounting happens when the demand for vehicles is weak.
Conclusion
The market is rallying because of the FBI clearing Hillary of any issues related to her emails. Unfortunately for the market, an earnings recovery wasn’t found in her emails. Regardless of who wins it makes sense to avoid stocks. I showed one of the bubbles in the economy which is autos. There are many bubbles because low interest rates means capital is chasing returns. This means excess risk is taken and money gets allocated to businesses which have flawed models. If Trump wins, the market will sell off much more than it is up today.
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