The optimistic but eerie calm that had settled over the US stock market since the US election ended abruptly this week, as the longest streak of trading days without a 1 per cent decline in more than two decades finally snapped. Equities clawed back some of their losses on Wednesday but investors remain on edge.
The post-election stock market rally has been largely powered by hopes the administration would swiftly launch a bevy of aggressive economic stimulus measures, such as tax cuts, deregulation and infrastructure spending. But the difficulty faced by the Trump government’s healthcare plan has forced investors to reappraise.
“One of the big questions this year has been whether equity market euphoria or bond market scepticism reflected the correct read on US policy risks with the new administration. With difficult negotiations on healthcare reform delaying tax reform, equities finally blinked,” according to analysts at Bank of America. “Volatility should be higher and we should see more days like this,” they noted of Tuesday’s drop.
Why the fuss?
After drifting downwards since reaching a fresh record high at the start of March, the S&P 500 suddenly fell 1.2 per cent on Tuesday. This was a fairly modest drop in a historical context, but it was the biggest dip since before the US election and the first 1 per cent-plus decline in 110 trading days — the longest such run since 1995. Treasuries rallied, the dollar sold off and US bank stocks suffered their biggest tumble since the UK’s Brexit vote, in what amounted to a hefty reversal for the most popular “Trump trades”.
The S&P 500 recovered its footing on Wednesday, closing 0.2 per cent higher. But the nervousness was evident as demand for safer assets pushed the 10-year Treasury yield to a three-week low of 2.4 per cent, bank shares edged lower again, and the dollar sold off against most of its major counterparties.
Moreover, exchange traded funds that track US equities suffered net outflows of $2.7bn last week, the first withdrawals in nearly two months, according to Credit Suisse. Retail investors that typically buy ETFs have powered the rally this year, while institutional investors have turned more cautious, so any sign that they are now pulling back is worrying.
What happens now?
US Congress will vote on Thursday on the Republican bill to repeal Obamacare, after party leaders made some amendments to mollify the concerns of both moderate and conservative Republicans. Mr Trump is attempting to rally support for the revised healthcare bill, but some are unconvinced, raising concern that it could fail to clear the House.
Despite the president tweeting that he was “working hard” on the bill, a spokeswoman for the conservative Freedom Caucus group said 25 of its members would vote against the healthcare plan, which would lead to a defeat for the administration.
If so, investors will have to question how much of the broader economic agenda can realistically be passed, which could cause a significant pillar of the post-election stock market rally to be put in jeopardy, says Brian Jacobsen, chief portfolio strategist at Wells Fargo Funds. “Tax reform is just as contentious as healthcare,” he points out.
Is this really just about healthcare?
The Washington imbroglio appeared to trigger this week’s stock market wobble, but many investors have grown increasingly concerned at stretched valuations and still-muddled economic fundamentals.
While softer economic data such as consumer confidence surveys have brightened considerably, the Atlanta Fed’s real time economic forecasting model still only points to a modest 0.9 per cent expansion in the first quarter, and estimates for corporate earnings have eased. Meanwhile, a recent survey of investors by Bank of America showed that more investors say equities are overvalued than undervalued than at any point since at least 2001, with US stocks highlighted as particularly overpriced.
James Swanson, chief investment strategist at MFS, the US mutual funds company, argues that the healthcare bill’s challenges were merely a trigger for a “deeper questioning” of whether the global economy is truly on the rise, pointing to continued concerns over China and still-underwhelming growth in Europe and the US.
“This isn’t just administration disappointment, but the fact that the global growth story is fraying,” he says. “The market is highly priced, and we are running into more signs that the cycle is turning.”
Is this the beginning of a serious correction then?
Probably not. Even some bearish investors doubt that concerns over healthcare legislation will be enough to reverse the market optimism that has reigned since last summer, which is based on more than just hopes over US tax reform and stimulus.
Citi’s global economic surprise index — which measures how often data emerges as better than expected — has been running at a near seven-year high for all of 2017, and central banks remain wary of upsetting a recovery that is only now beginning to gain traction.
“We are just recalibrating the reflation trade, as there still seems to be a global synchronised recovery,” says Charles De Vaulx, chief investment officer of International Value Advisors. “The fact that I want a correction doesn’t mean I believe we will have one now.”