How are markets reacting to Trump’s political mess?
Matein Khalid looks at the roller-coaster ride in US equities
The financial markets finally cottoned on the increasingly sordid political realities created by the Trump White House. Trump could well be impeached for obstruction of justice if he tried to pressure former FBI director James Comey to drop an investigation on disgraced General Michael Flynn’s contacts with Russian intelligence before the election. The appointment of a special prosecutor to investigate the scandal means Washington is now mired in a constitutional scandal that will make it impossible for the Trump administration to enact its tax reform/deregulation agenda.
This was the reason the Dow Jones index plunged 372 points, the ten year US Treasury yield sank to 2.20 per cent, the Nasdaq fell 158 points and safe havens like the Swiss franc, Japanese yen and gold surged against the US dollar on Wednesday.
The political scandal in Brazil and the meltdown in the Bovespa and the real has only amplified the angst in risk assets. Is the Wall Street sell off just an ephemeral market or something more ominous, a trend change, requiem for the bull market?
The US stock markets’ “irrational exuberance” since the election was based on sound macro-economic logic. First-quarter earnings were a beauty. Jobless claims are at a 28-year low. Housing, gasoline prices and wage growth still anchor consumer spending. Silicon Valley’s tech revolution once again has mesmerised the world. Yet Mr Market more than priced in all the good news at 18 times earnings and stratospheric valuations in Dr Schiller’s CAPE index. The stock market discounts the future, not extrapolates the recent past — and the future has darkened since Robert Mueller’s investigation could well lead to the political demise and possible impeachment of Donald Trump. This is Watergate 1974 all over again, not exactly a benign backdrop for the US or world economy at a time of epic geopolitical tensions in North Korea, Syria and Iran. Treasury Secretary Steve Mnuchin’s testimony to the Senate Banking Committee, while suave and optimistic as befits an ex-Goldman Sachs partner, has not exactly reassured Wall Street. Thursday’s price action is a classic dead-cat (actually kitten!) bounce though the Dow rose 140 points on Friday. Trump’s decision to renegotiate the Nafta creates yet more uncertainty in international relations and trade policy. Trump’s decision to go to Saudi Arabia, the Vatican and Brussels on a state visit will not end the turmoil in Washington.
Financials were the quintessential Trumpflation sector since faster economic growth, a repeal of Dodd Frank, tax cuts and a steeper US Treasury bond yield curve fatten bank profits. So it was no coincidence that Bank of America and Goldman Sachs, the poster boys for the post-election money centre bank rally, both lost five per cent in a single session on Wednesday. I believe financial stocks must not roll over or the bull market is toast. The fall in the US Dollar Index below 98 and the 10-year US Treasury note at 2.20 per cent tells me that the capital markets have scaled down their expectation of aggressive Federal Reserve monetary tightening this autumn. Will Janet Yellen raise the Fed Funds rate at the June FOMC? Yes, the logic of the Fed’s dual mandate has flashed green. Will a political crisis in Washington shape the time of the Fed’s balance sheet normalisation? Yes. This is the reason I am no longer willing to accept the risk reward calculus in most money centre bank shares and now await Citigroup’s fall to 56 or Goldman Sachs below 200.
Technology’s megacap darlings and the Philly semiconductor index have also been fabulous money makers in 2016 and 2017. In fact, it is impossible to trade the S&P 500 index or Nasdaq without a continual real time grasp of the bull-bear debate in Facebook, Apple, Netflix, Google and Amazon. These are the megacap colossi who dominate the world’s biggest stock market indices. If the bull market dies, expect carnage in these Big Five shares as the sheer tsunami of leverage index selling hits Wall Street. Donald Trump’s fate is now in the hands of the 535 men and women in Capitol Hill who run American politics. The fate of the bull market on Wall Street also could also been in the hands of the Congress — and the special prosecutor who will investigate whether Donald Trump colluded with the Russians — and then lied to the American people about it. The ghost of Richard Milhous Nixon, now haunts Wall Street.