Brexit 2.0: Why the U.S. Election Could Roil Equity Markets

Deja vu?

Nearly five months ago, voters in Great Britain did the unthinkable when they cast ballots in favor of severing their nation’s more than 40-year membership in the European Union. The decision sent shockwaves through global markets and uncertainty raged about the future of the U.K.’s economy and its global trade deals. Now, the November 8 U.S. presidential election – just days away –has the potential for the same kind of reaction.

A bombshell announcement on Friday from the FBI about a new batch of emails from Hillary Clinton threw back into question what looked like an all-but-certain win for the Democratic nominee. What was a seven-point lead in mid-October for Clinton over Republican nominee Donald Trump, narrowed to a 1.7 point spread, according to the RealClearPolitics polling average.

As the polls and betting odds have proved, history has a way of repeating itself – even just half a year later. The global market’s panic in the wake of the unexpected so-called Brexit decision serves as a kind of template for what could happen in the U.S. should Trump score a victory at the ballot box, according to Peter Kenny, Global Markets Advisory Group senior market strategist.

“It’s utterly amazing to see parallels continue to unfold; there’s very clear symmetry between what happened in Brexit and what’s happening in the U.S. on so many different levels. From the unseeming popularity of Trump’s candidacy relative to Brexit, to a complete turnover of British leadership and what will be turnover in Washington if Trump wins,” he explained.

U.S. equity markets have been in a relative holding pattern in the weeks after Labor Day with the S&P 500 having traded in a 60-point range during the period. That’s despite corporate earnings that appear to have broken out of a profit recession in the third quarter, a wave of blockbuster merger-and-acquisition activity, and upbeat economic data showing the labor market, inflation and health of the American consumer continued to rise.

As voter sentiment has adjusted, so have the equity markets. On Tuesday, the major averages kicked off the month of November on a decidedly negative note, as the S&P 500 fell to its lowest level since July. Investors fled risk assets as they sought the safety of havens like gold, which saw a price increase of more than 1%, the precious metal’s biggest gain since early September.

With markets in the midst of a repricing scenario, Kenny said Wall Street could see a significant drop in equities after the election should Trump secure the White House, though he doesn’t see it lasting long. The case is similar to the Brexit-style selloff in global markets. The U.K.’s  FTSE 100 plunged 3.1% following the vote, but has, in the months after, rallied more than 8%.

“I do think we will see a very substantial and meaningful rebound in equity prices over the long term because his approach to the economy is radically different than what we’ve seen for 16 years and what the markets are going to find is healthier for U.S. companies. But in the near term, Trump represents more risk than Clinton,” he said.

Ameriprise Financial chief market strategist David Joy agreed that whatever selloff in equities happens after the election would likely be short-lived, and the catalyst would come from the simple nature of markets reacting to an unexpected outcome. After a candidate is elected president, Wall Street would also need to assess which party controls Congress and the likelihood of proposed policies by the new commander in chief getting through the legislative body.

“It would probably result in some kind of spike in short-term volatility as thinking would have to be reoriented in terms of expected policy initiatives,” Joy said. “In the short run, it would lead to something of a selloff while risk is reassessed, but that would probably get washed out of the market quickly.”

Whatever sharp market reaction happens on and after November 8 likely won’t all be due to the election, Kenny said. Thanks to stretched valuations, technically weak markets and major averages trading below their 50-day moving averages, markets are already in a compromised position.

To that end, economists at Goldman Sachs (NYSE:GS) warned against drawing too many direct comparisons to the U.S. election and the U.K. referendum. They cited two variables that have been very different in the U.S.: American voters are deciding first on an individual to lead the nation and not an idea to change the status quo; second, even though they’ve tightened substantially, polls are not as close as they were in the U.K. ahead of the Brexit vote.

“While one cannot rule out the possibility of an election surprise, most of the theories as to how this might occur are not borne out of the recently available data,” they said in an October 26 note. “While a shift in turnout could upend the models most pollsters use, there are no signs thus far in early voting that such a shift is occurring.”

From an economic perspective, if there’s one thing to be concerned about, it’s the election’s impact on American consumers, said Euler Hermes North America Chief Economist Dan North. In the event of a sharp knee-jerk reaction in the financial markets – regardless of which candidate wins – it could weigh on consumption during the all-important holiday-shopping season.

In September, consumer spending, which accounts for more than two-thirds of U.S. economic activity, saw a slight rise to 0.5%. Meanwhile, the University of Michigan’s gauge of consumer sentiment unexpectedly fell last month

“Let’s say there’s a Brexit reaction move to the downside, at the same time, you have a candidate that roughly half of the population doesn’t like. Will that crimp consumption in November and maybe December? You could see a bit of an effect [on retailers] since many of them live and die by that retail season,” North said.

While it could weigh on fourth-quarter earnings results and holiday sales figures, North doesn’t anticipate a possible drop in consumption or consumer confidence will impact the Federal Reserve’s much anticipated December rate-hike plans. In his view, the central bank is more focused on efforts to boost inflation, which has been slow to move higher in recent months. Core personal consumption expenditures (PCE), the Fed’s preferred inflation gauge, slipped slightly to 1.7% in the third quarter from 1.8% in the second quarter, though recent employment data have shown slight wage pressure.