5/19/17 – Political Headlines Drive Volatile Week

Volatile Week Ends On A Positive Note

Wednesday saw stocks suffer their worst day since September, with the Dow declining over 370 points, or almost 2%. However, strong rally today reversed most of the week’s losses. The Dow and S&P 500 each declined 0.4% on the week.

Special Prosecutor – Growing concerns about Trump’s ties to Russia and potential obstruction of justice charges surrounding the hiring/firing of Michael Flynn and the firing of FBI Director James Comey spooked markets Wednesday. The view was an investigation could derail the Trump economic agenda that some argue has helped propel stocks since the election. There are two main views of what has driven the relatively strong market this year. First, market expectations of a corporate tax cut and deregulation has increased future earnings’ outlooks for companies. That in turn has pushed stock prices higher. Second, corporate earnings are experiencing strong growth this year regardless of future tax/regulatory policy and that is the primary cause of higher prices. I think it’s more of the latter, but both have been important.

Corporate earnings have been strong and corporate forecasts have generally been better than expected this year. This is true earnings growth and that growth supports the higher stock market. If we get corporate tax reform, that will be another large boost to corporate earnings, but current analyst estimates aren’t based on a lower corporate tax rate. From that viewpoint, the sell-off Wednesday seemed overdone. If something does happen with Trump, markets still have a reasonable expectation of corporate tax reform with a President Pence. Read More

US GDP Growth – For basically the last 16 years, the US economy has grown at an underwhelming ~2% annual rate, on average. From the end of WWII through 2000, the average was 3.1%. A key piece of Trump’s economic and tax plan in based on getting growth back to 3%. Right now, the bond market isn’t buying the rosy growth projections. The 10-year Treasury bond is yielding ~2.2% currently, down about half a percentage point from December. This tells me the bond market doesn’t think there’s any chance growth will reach 3% in the coming years. It’s worth noting, the bond market is notoriously pessimistic. There’s an old joke that the bond market has correctly predicted nine of the last five recessions. Meaning it often fears recessions that never happen. It is interesting though to see the divergence in expectations between the equity and bond markets.

Oil moved sharply higher this week, increasing 5.3% to close at $50.41/barrel. The yield on the 10-yr Treasury decreased, closing at 2.24% from 2.33% a week ago. The average rate on a 30-yr fixed rate mortgage ticked lower to 4.02% from 4.05% last week.

Close Weekly YTD
Dow Jones 20,804.84 (0.4%) 5.3%
S&P 500 2,381.73 (0.4%) 6.4%
Oil 50.41 5.3% (6.5%)
10-yr Treasury (∆ in bps) 2.24 (9) (21)

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