February 21, 2019 / 12:53 PM / 3 months ago

Breakingviews - Cox: Impeachment hedge runs through Saudi Arabia

PARIS (Reuters Breakingviews) - What’s the best way to play the impeachment of the U.S. president? That’s a question that investors are pondering as Special Counsel Robert Mueller’s investigation into Donald Trump’s ties with Russia, and other stuff, finishes up.

U.S. President Donald Trump shakes hands with Saudi Arabia's Crown Prince Mohammed bin Salman in the Oval Office at the White House in Washington, U.S. March 20, 2018

Democrats, who now control the House of Representatives, appear eager to use Mueller’s findings to commence a process of defenestration. Fund managers, including so-called “macro investors” who make large bets on currencies and interest rates, have a few ideas to trade what might happen next – the most intriguing of which runs through the Kingdom of Saudi Arabia.

There’s little consensus on how measures to oust the president by constitutional means would affect financial markets. Putting aside their own political biases or personal views on Trump’s stewardship, investors don’t have a clear answer from history for how to position their portfolios. The two historical antecedents of the past half-century offer conflicting messages.

The last American commander-in-chief to experience impeachment by Congress was Bill Clinton, just over 20 years ago, for lying to a grand jury and obstruction of justice. The charges failed to achieve a super-majority in the Senate, needed to remove a president. In the 12 months leading up to December 19, 1998 – when the House cast its vote – the S&P 500 Index had risen 27 percent. In the following year, the index rose another 19 percent.

The case against Richard Nixon in 1974 suggests a rather different outcome. From the start of the acute phase of the Watergate scandal to Nixon’s departure from the Oval Office in August that year, the average had tumbled 40 percent. In just the year leading up to his August 9 resignation, the S&P fell 23 percent. It rose just 7 percent over the next 12 months.

If there’s anything to glean from the two situations, it’s that broader economic conditions have more influence than politics on equity returns. In Nixon’s case, some of his other policy decisions, such as withdrawal from the Bretton Woods Accord, ending the convertibility of the dollar; and geopolitics, including the Yom Kippur War and corresponding OPEC oil embargo for America’s support of Israel, mattered more than impeachment or resignation.

Similarly, the booming economy of the Clinton years encouraged investors to ignore the political investigation into the Democratic president’s personal infidelities. American GDP grew by more than 4 percent annually in the last two years of the 20th Century, thanks to the first internet-fueled investment boom, leading to a rare federal government fiscal surplus.

Investors still need to consider hedging their bets. The chances of an impeachment by the House are greater than zero. Betting markets, like those monitored by PredictIt, forecast a near-30 percent chance of it happening before 2020. That’s in line with informal polls conducted by Breakingviews at Predictions events last month. Some 80 percent of attendees voting in New York in January gave impeachment a 30 percent or higher probability.

The bottom line comes down to whether the economy and corporate earnings would continue to grow. If two-thirds of the Senate approved removing Trump, economic policy would pass to an administration led by Vice President Mike Pence. He’d likely pursue a traditional Republican agenda of lower taxes and minimised regulation – not much different from the Trump administration. All things being equal, that might help stocks.

On the other hand, the looming effects of Trump’s loose fiscal policy could lead to higher interest rates, which might dampen growth and corporate earnings. Hence there’s no clear direction one way or the other to posit from a Trump impeachment. Or as one investor explains cynically: “all the smart people who have been busy saving in the world are all going to have a different view on the U.S. economy.”

Which leads to Saudi Arabia. If there’s one stark difference of opinion between the president and legislature, it’s in their approach to Crown Prince Mohammed bin Salman. In December, a vote to end military aid for the kingdom’s war in Yemen, and to blame MbS for the killing of Saudi journalist Jamal Khashoggi, received 56 votes in the Republican-led Senate, an unusual rebuke to the White House. Last week, the House voted 248-177 in favor of a similar motion.

Trump will oppose any bill that crosses his desk. And neither chamber mustered sufficient support to override a presidential veto. But it illustrates how crucial – even existential – the president’s support is for MbS. A weakened or impeached Trump would remove the last protection Saudi currently enjoys from the wrath of Congress. That could allow legislation such as the current bill, and additional sanctions, to become law.

How Riyadh would respond is hard to say. In the past it has weaponised the price of oil, primarily by cutting production. Even if that didn’t happen, opponents of MbS could be emboldened to try to depose him, potentially disrupting oil production. Though the United States is a major energy producer, the higher oil prices that would arise from either outcome would hurt consumers, dent profits, slow the economy and hurt the stock market.

Hence the play. One-year options to buy West Texas Intermediate Crude at $100 a barrel currently cost about a quarter of one percent. At an average price this year of around $52 per barrel, they’re way out of the money. A return to three-digit oil following a Saudi supply shock, then, would deliver a massive return. True, chaos in the kingdom would have lots of other knock-on effects, as would an abrupt end of the Trump presidency. But even in bedlam there’s money to be made.

Breakingviews

Reuters Breakingviews is the world's leading source of agenda-setting financial insight. As the Reuters brand for financial commentary, we dissect the big business and economic stories as they break around the world every day. A global team of about 30 correspondents in New York, London, Hong Kong and other major cities provides expert analysis in real time.


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