Long-term investors could take a week off

Markets to be impacted more by US polls than corporate balance sheets

The outcome of the US Presidential elections, obviously, has some long-term effect on financial markets, since the individual in the Oval Office has a great deal of influence over the global economy. It also has short-term effects, based on trader perceptions.

In terms of perceptions, there is a lot of polarisation. Romney is seen as business-friendly and committed to a lower tax regime, with low social security spending. Obama is seen as more likely to push for a higher social security regime, higher taxes and to be, in general, less business-friendly. These perceptions may be plain wrong and one could argue, as several economists have, that Obama is likely to do a better job if one is looking at the long-term health of the economy. Nevertheless, these perceptions exist and are unlikely to change within next week.

Given the perceptions, there could be a couple of interesting movements in the global financial markets next week. One is volatility in the dollar rates versus most other currencies, including the rupee. There’s a historical trend of dollar strengthening in the 5-10 sessions after the US election is over. The dollar is likely to strengthen more if Romney wins but will probably strengthen anyhow as soon as the election results are declared.

This tends to be a temporary effect but could be a potentially big trade, with some traders predicting the rupee could drop below 55. Given high brokerages in the currency futures market and the extremely high leverages, a long dollar/rupee position is risky. There is also little fundamental justification for this effect. It is just a sort of expression of relief that the US elections are over. If there is confusion about the outcome, as in 2000, it’s possible the dollar would weaken until such time as the election results are known.

Another temporary effect could be a sudden surge in bullish stock market activity if Romney wins. If one looks at funding patterns, it is undoubtedly true that Romney has a lot of financial support from Wall Street. It’s possible this could translate into the buying of equities if the Republican candidate comes through.

Again, this effect could be global in its impact, even if temporary in nature. The supposedly business-friendly nature of the Romney-Ryan ticket might trigger a surge in equity prices if they win. There is the converse possibility that an Obama repeat could lead to a pullback and correction. In the Indian context, this could show up as increased net foreign institutional investment inflows and, of course, a rising stock market.

None of these correlations is strong enough to bet your shirt on. It would not be very surprising if Romney won and the financial markets failed to respond with much enthusiasm. It is also entirely possible that Obama will win, which is less likely to excite the markets. One can say, however, that a Romney victory will be more likely to push up equity prices and dollar rates in the short run.

Whichever candidate eventually wins, the chances are good that market movements over the next week or so will be driven more by breaking news from the US polls than corporate balance sheets. If you’re willing to dabble in potentially risky and troubled waters, there could be extremely lucrative trading opportunities.

Otherwise, it probably makes sense to stay out of the market until the outcome of the elections is clear. Price swings, especially in businesses with dollar exposure, and with high levels of FII interest, could be pretty extreme. A long-term investor can just take the week off and avoid the potential volatility and the consequent mental stress.