General Flynn Pleads Guilty. Increased Political Risk To Weigh On US Stocks S&P500 (03 Dec ’17)

We recently published a short report, “US Equities S&P500 Encountering Increased Technical Headwinds”. As well as highlighting technical developments, we also mentioned increased political risks.

 

Tactical Legal Decisions

Following General Michael Flynn’s guilty plea on Friday 1st December to Making False Statements to the FBI, we believe these risks could be increasing, and anticipate investors will be watching both political and legal developments with much more interest.

As explained in a series of tweets by Attorney and Professor of Law, Seth Abramson, because of his senior position within President Trump’s administration, General Flynn was going to be a primary target of Special Counsel Robert Mueller III’s Russia probe.

One point of analysis by Professor Abramson is the relatively ‘minor offence’ to which General Flynn has pleaded guilty. Whilst making false statements to the FBI is already a serious offence, Professor Abramson argues this admission of guilt is a tactical move on the part of Special Counsel Mueller.

It is believed that General Flynn has struck a plea bargain deal in return for providing inculpatory evidence on other senior members of President Trump’s Administration.

When looking at General Flynn’s position of National Security Advisor, there are only 2 people above him in the executive-branch hierarchy. They are Vice President Mike Pence and the President himself.

If the legal analysis is correct, then America is on the cusp of a generational political crisis.

 

Deep Political Crisis?

In the event of a President becoming unable to perform his duties, eg incapacitation, death, impeachment and subsequent conviction, the United States Constitution and the Presidential Succession Act of 1947 provides a clear line of succession.

If President Trump is no longer able to perform his duties, VP Mike Pence will be installed as the new President of the United States.

Can VP Pence assume the Presidency?

However, VP Pence could also be implicated in Special Counsel Mueller’s Russia probe.

In mid July 2013, then-governor of Indiana Mike Pence was introduced to Donald Trump as a potential VP by Paul Manafort. However, Manafort himself is being investigated in the Russia probe, and was recently indicted on 12 counts of money laundering.

Additionally, there is the possibility, during the transition phase, that General Flynn talked to Mike Pence about General Flynn’s Russia contacts. (It is illegal, under the Logan Act, for civilians to negotiate with foreign governments who are in dispute with the US.) If it transpires that Pence lied about knowing of General Flynn’s illegal contacts with the Russians, then this could nullify his succession.

If the VP is unable to accept Presidential duties, the next in line is the Speaker of the House of Representatives – Paul Ryan.

However, Speaker Ryan is also a potential person of interest in the Russia probe.

“Real Family”

In mid-May 2017, the Washington Post published an article which referenced a recorded conversation between Paul Ryan and, amongst others, Congressman Kevin McCarthy. The recording, dating from mid-June 2016, mentions McCarthy’s belief that Donald Trump, as well as US Representative Dara Rohrabacher, are being paid by Putin. Speaker Paul Ryan is very quick to stop the conversation, and swears those present to secrecy. “No leaks… This is how we know we are real family.”

If, for whatever reason, it transpires that Speaker Ryan also cannot assume the Presidency, the next in line is Orrin Hatch.

At 83 years old, Senator Hatch, citing health issues, has mentioned the possibility of stepping down from another term.

Moving away from the line of succession, there are also comments to the effect that, should the Russia probe prove interference, then the WHOLE of Trump’s tenure, including nominations and legislature, should be declared null and void.

There is no legal precedent for this, and arguments are still ongoing.

 

Investors do not like uncertainty

Collectively, what this means for the USD denominated investor, is an increase in portfolio risk.

There are many “what if” statements in the above, and whilst they may ultimately turn out to be of little importance, what they DO highlight is uncertainty.

One thing investors generally do not like is uncertainty.

Whether it is natural uncertainty, for example weather related, or, as we currently have in America, political risk, investors will always look to minimise their exposure to these factors, and move towards a more neutral stance.

As a fledgling spot trader, when news was breaking, my then boss, Akis Karayiannis, would ask, “Is this good or bad for the USD?”

The obvious answer to the current developments would be – “it’s bad for the USD and US stocks.”

Rebalancing of USD denominated portfolios?

As political risk increases, investors become progressively more concerned with their portfolio exposure. The natural reaction is to reduce positions and move into ‘safer’ markets.

 

Longer term charts show S&P500 weakness relative to CommoditiesWhilst we believe US stocks will come under increased pressure in the coming months, we cannot rule out the possibility that the current strong rally in the S&P500 Index will continue into the coming weeks. Short-term momentum and sentiment remain strong, but there are signs of investor caution appearing, as the broad equity market begins to show increased underperformance relative to commodities.

 

 

 

Our recent report, “Could Asset Rotation Weigh On US Equities S&P500 Into The Coming Months?” provides some ideas on this theme.

We also believe volatility will turn higher, as investor sentiment becomes progressively more concerned with political developments.

 

Conclusion

As the Russia probe moves steadily higher in the current US Administration, the US is moving towards a potentially historic Constitutional crisis. We believe investors will become progressively more cautious of their USD based portfolio allocations. Risk averse investors will likely begin to reduce their exposure to US equities, and look for better investment opportunities. We believe commodities can provide value. We anticipate cross asset rotation into selected commodities sectors will increase into the coming months.



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