People are bothered that the markets are so unbothered by the political fuss and ferment in Washington.
As President Trump helps fuel conflict and alarm among political parties, other branches of government and the D.C. media, Wall Street is as calm and unhurried as it’s been in decades. Amid the sudden firing of an FBI director and even warnings of a Constitutional crisis, the major stock indexes have spent the past two weeks in a vanishingly tight 0.8 percent range near their record highs.
The market’s favorite trick is to act in confounding and counterintuitive ways, but this apparent disjunction has even some seasoned investment professionals scratching their heads and interrogating their financial models.
S&P 500, 1 month
Calling it “a worrisome disconnect,” strategists at Goldman Sachs last week argued, “The juxtaposition of rising policy uncertainty vis a vis declining fear in risk assets raises cause for pause, in our view.” They suggest the chances for business-boosting policy moves are waning as Washington bogs down, which could weaken business confidence, stall corporate merger activity and disappoint investors.
Perhaps there is an untenable disconnect, and maybe it will prove to be a concern for markets.
Yet there are a few possible explanations for why the S&P 500 has managed to hover quietly near its record high as the Washington drama thrums ever more loudly.
That’s not what markets do.
Financial markets don’t routinely reprice according to shifts in the public mood or the relative effectiveness of leaders, they work to discount future corporate cash flows and interest rates.
The CBOE S&P 500 Volatility Index (VIX) – which everyone keeps accusing of blithe negligence for staying near all-time lows – is not a gauge of political dissension or executive malfeasance. It’s a statistic derived from the prices investors are willing to pay, in real money, for options that protect against a market drop or surge in volatility over the next 30 days.
The histories of the bruising 1973-’74 bear market hardly even mention Watergate as a contributing factor. It was mostly about an expensive stock market blindsided by the Arab oil embargo, spiraling inflation and the Federal Reserve raising interest rates into a weakening economy.
In the middle of World War II, following the Battle of Midway in 1942, the Dow industrials surged 40 percent in a year even as the war news remained bad and the outcome unclear. During the Reagan-era Iran-Contra affair of the mid-’80s, stocks continued heading steeply higher. Same as during the Clinton-impeachment scandal of the ’90s. After the 9/11/2001 attacks, the Dow fell a quick 7 percent then rallied by 20 percent the next three months.
Sure, if this were a skittish market beset by multiple challenges and looking for an excuse to pull back hard, the political headlines could easily serve the purpose. But that’s not the current market, which is supported by lots of liquidity and cooperative fundamentals – for now.
Policy magic is not priced in.
I’ve argued for months that tax- and infrastructure-policy hopes have not been a key driver of stocks’ strength since early this year. The Trump trade was a five-week burst of buying in some under-owned cyclical and financial sectors after the election, followed by a broader rebound pegged to global growth and an earnings rebound.
This seems clearer now as the market leadership has shifted to very large technology stocks and not the high tax-rate, domestic companies that would reap most from a corporate tax cut.
Granted, the hope for policy movement at some point is certainly part of the psychological backdrop among investors, who are giving this market the benefit of the doubt. If we were somehow told definitively that no stimulative tax or spending legislation will pass during this Congress, might it prompt an overdue market pullback? Plausible, sure. But that doesn’t mean policy is an essential prop to the market just now.
Lindsey Bell, strategist at CFRA, notes that earnings forecasts for the full year are holding up unusually well. This provides fundamental cover for investors buying stocks at current expensive valuations.
Bell says: “The largest risk to the outlook resides in the third and fourth quarter estimates, as the consensus numbers haven’t moved much. The market and analysts are seemingly pricing in lofty benefits from President Trump’s potential policies on tax reform, infrastructure spending, repatriation and deregulation, preventing analysts from adjusting estimates further downward.”
It’s hard to prove. Maybe policy hopes are supporting analyst forecasts for now, or not. If so, perhaps the “worrisome disconnect,” if that’s what this is, will get tested in coming quarters.
Maybe the market is responding to the DC drama.
Investors and traders seem bereft of any conviction lately.
Trading volume last week in the huge S&P 500 Spyder ETF was 28 percent below average, the slow pace of a major-holiday week. Cash has been pulled from domestic stock funds over the past two weeks.
Maybe this is the investment community being wary and watchful of what the jarring political headlines might, or might not, mean for the economic agenda, consumer confidence and business spending?
And let’s not forget that before Election Day 2016, it was common to celebrate how much the stock market benefited from Washington gridlock and policy paralysis. A state of enforced gridlock followed the 2012 election, and plenty of observers credited this with at least part of the market’s 30 percent gain in 2013.
For sure, the market can’t stay this placid for terribly long, and it certainly would be rattled by some political development or another – an ill-advised and impulsive military action, or the president’s open defiance of Congress, say.
And perhaps this market would be jumpier if it were more driven by the heavy participation of individual investors rushing in and out of individual stocks, rather than index funds, asset-allocation models and quantitative strategies.
But it’s not. And, so, for the moment, the market is not extrapolating recent political events out to some unknowable outcome that might or not matter for the economy – because that’s really not what markets do.