August 9, 2016

Why the markets could under-perform if Donald Trump quits the presidential race

In June, I wrote in Another Surprise that for the first time in history, a major party's presidential nominee would likely withdraw in the middle of the race:

    Surprise No. 16: Trump Bows Out

    "Donald Trump bows out of the presidential race some time between the Republican National Convention and Election Day." - Doug's Daily Diary, Another 2016 Surprise: 'The Trump Mutiny' (June, 2016)

People were skeptical of that call. (Indeed, many thought I was out of mind.) Now, none of this is meant to be a personal political statement.

Some six weeks after writing that, I now believe a Trump withdrawal is a more likely than ever. In fact, this might even represent a new baseline assumption for investors.

Now, there are certain things -- a degree of respect, a solid political organization, a thorough thought process, etc. -- that many believe all presidential candidates need. But arguably, Trump's tone and tactics don't conform to any of these.

From 'Chaos Candidate' to 'Kamikaze' One

No one seems able to control Trump -- not his family, not campaign chief Paul Manafort and certainly not Republican National Committee head Reince Priebus and the rest of the GOP leadership. In fact, Trump's recent behavior has become so aberrant and self-destructive that there's talk of top Republicans pleading for an "intervention."

I would challenge anyone to find an historical precedent to Trump's behavior over the past week. It defies political or intellectual reasoning. To some, The Donald appears bound and determined to destroy his own campaign, family and party. It almost suggests that Trump doesn't want to win the election -- something I consider a very real possibility.

Bleeding in the Polls

As I suggested in June might happen, the polls are starting to trend well in favor of Clinton over Trump. For example, a Fox News survey out this morning has Clinton with a 10% advantage. Even more importantly, Clinton's lead in swing states like Michigan and New Hampshire is now expanding.

I expect Trump's bleeding in the polls to only grow more conspicuous in the coming weeks. Next month's first presidential debate will be an important factor in determining whether my predictions come true. If Clinton wins the debate, that could easily move her lead in the polls toward 15%.

Top Republicans May Scorn Trump

A critical issue is whether top Republicans will come the conclusion that The Donald is more of a stain on the party than a standard-bearer.
For now, leading Republicans are laser-focused on defeating Clinton. But Trump's recent decision to not yet endorse the re-election of top Republicans like House Speaker Paul Ryan, Arizona Sen. John McCain and New Hampshire Sen. Kelly Ayotte could lead to senior GOP members to renounce support for him.

My guess is that McCain could be the first to break ranks and do so. But if Trump's poll numbers get bad enough, it'll become increasingly difficult for high-profile Republicans in tough re-election races to defend his behavior. They'll likely break away from the candidate as the cost of supporting Trump exceeds the benefits.

The Surprise

With tumbling polls, dwindling endorsements, a lack of organization and an absence of big donors like the Koch Brothers, Trump will likely enter the first debate as a dangerously exposed candidate.

Hillary Clinton with Warren Buffett
If polls show Clinton trouncing him after this one-on-one, I expect that will tip Trump's candidacy over. The embarrassment of a potential landslide loss to Clinton could serve as a breaking point for Trump, who doesn't like to lose or look bad.

In that scenario, The Donald would announce that he's "no longer an active candidate" -- in effect, quitting the race. Trump would remain on the ballot, but Clinton would essentially run unopposed. The Donald would likely blame his decision on others, perhaps stating that his party was not supportive to his candidacy or that the system is "rigged."

More Gridlock

Of course, this wouldn't necessarily mean that the Democrats would control the federal government.

After all, Republicans currently hold majorities in both the Senate and House, and I suspect they'll at least retain the House after November. To control both congressional chambers, the Democrats would have to pick up at least 30 House seats and five Senate seats if Trump wins the election or four if Clinton does (a Democratic vice president would break a 50-50 tie).

So, let's say that the Democrats take the Senate and win more than 25 House seats but the GOP still retains control of the lower chamber. What does that mean going forward? Two words: "More gridlock."

Possible Market Ramifications

With the Federal Reserve losing its effectiveness, the scenario outlined above would mean that needed fiscal stimulus simply won't happen. Even though I believe many investors' baseline expectations call for it, there'd simply be too much gridlock and partisanship in Washington.

Recognizing the dwindling policy alternatives to catalyze growth, global markets would then plunge during the fourth quarter.

That's one reason why I'm net short in the market.

Position: Long SDS, Short SPY