DOW DROP CATCHES INVESTORS’ ATTENTION
Trump Trade could have run out of steam
AFTER HUGE RUNUP AT START OF THE YEAR, COULD TRUMP TRADE HAVE RUN OUT OF STEAM?
One thing we should all have learned about the U.S. bull market ( some of us more than others) is that calling its end is a mug’s game. Over its nine- year run, it has repeatedly defied global crises, electoral surprises and bearish predictions, and then gone on to reward the faithful with new records. The benchmark S& P 500 index started 2018 with its best performance since 1987, and at the end of last week had yet to record a single losing session this year.
And then this week happened.
On Monday, the S& P 500 declined by 0.67 per cent, its worst one- day performance in five months. On Tuesday, the slide continued, with the index falling more than one per cent, marking the first back-to-back declines of more than 50 basis points in 310 trading days. That’s, like, a long time.
Some market- watchers laid blame for the poor showing this week to a report that Apple Inc. was halving production of the iPhone X; the tech giant’s stock dipped more than two per cent on Monday. But that doesn’t explain everything, even if Apple comprises the biggest single element in the S& P 500( about 3.5 percent of it).
Well, so what? Two days makes for an extraordinarily small sample size, and t here’s nothing magical about breaking a 310- day trend or whatever. All markets, bullish ones included, have ups and downs, and in the absence of any significantly different underlying conditions, why would anyone think this signals the end of the run? A string of up sessions will quickly put Monday and Tuesday in the rear-view mirror.
But what if this week really is the turning of the tide? What would be driving it? Unfortunately for your portfolio, it could be a lot of things.
Maybe part of it has to do with the so- called Trump Trade having nowhere left to run. For months now, markets have been pricing in the positive impact of t he Republican t ax bill, which is expected to spark a rise in corporate earnings and concurrent benefits to shareholders, and of the Trump administration’s deregulation promises. Now, however, investors might r e asonably be wondering what’s next. The White House has gone nowhere on its promises of big infra- s t r ucture s pending, f or instance, and its quiver of economic stimuli might be running empty. In short, markets might be asking Trump: What have you done for us lately?
Or it could be something else. In previous corrections during this bull market, investors could always fall back on the fact that interest rates were incredibly low, which supports equity valuations. But, relatively speaking, that is no longer the case.
Central banks are shifting course. The European Central Bank, in response to a strengthening economy that pegged three- per- cent GDP growth last year, has sig- nalled it might move more quickly on winding down quantitative easing; earlier this week, five- year German bund yields entered positive territory for the first time since 2015. Meanwhile, the U. S. Federal Reserve is leading the normalization drive, having hiked its target rate three times in 2017; according to its most recent dot plot, which tracks committee members’ rate expectations, another three hikes might be on the way in 2018. And the unwind of the Fed’s multitrillion- dollar balance sheet is well under way.
U. S. Treasury yields have finally begun to move up. Ten- years have risen nearly 25 basis points this month, to 2.7 per cent; two- year yields have risen by nearly 20 bps ( which, if you’re afraid of the flattening yield curve as a classic sign of impending recession, is not exactly a huge comfort). More to the point, rising rates, should they continue or accelerate, could have an impact on equities, and the runoff might not be smooth.
Already, U. S. dividend stocks have been taking a licking in the face of rising yields, which make safe- as- houses Treasuries look more attractive to investors. But the damage might not end there. For years, low bond yields have underpinned soaring equity valuations, which offered attractive risk premia even at record prices. With 10- year Treasuries offering just 2.3 per cent, as they were this time l ast year, t he S& P 500’ s earnings yield of four per cent ( calculated as the inverse of a 24.7 price- earnings ratio) might look like a deal. But with Treasury yields on the way up, the equity edge is narrowing. How attractive will stocks l ook if or when 10- year Treasuries hit t hree per cent?
Well, we don’t know. It might well be the case that the Trump tax cuts and resurgent global growth will boost U. S. ( and global) corporate earnings enough to extend the rally. Inflation, in the U. S. and elsewhere, is still low.
Yet with GDP growth strong, unemployment low and fiscal stimulus taking effect in the world’s largest economy, expectations for inflation are on the rise, at the very least among central bankers.
If they tighten financial conditions too much, ahead of an inflation threat that doesn’t materialize, or if they raise rates more quickly than markets expect — well, a one-per-cent one-day decline on the S& P 500 might end up looking like nothing.
U.S. DIVIDEND STOCKS HAVE BEEN TAKING A LICKING IN THE FACE OF RISING YIELDS.