Can Stocks Become the Market Vigilantes? – Week Ended 8/25/17

US equities broke their two-week losing streak with the S&P500 advancing +0.7%; US political noise seemed to cool slightly from what has otherwise been a disgusting month of turmoil and backlash against the President by both parties. Despite the favorable weekly result, the daily path of the market remains relatively choppy compared to the low volatility experience observed over the first 7 months of 2017. Indeed, most are pinning the recent uptick in volatility and daily swings to none other than the unpredictable rants and feuds being generated by Donald Trump. No other way to put it than a huge distraction from meaningful progress. And in a slow-growth economic environment that is hopeful for any ingredient including less restrictive policy to spur an faster pace of growth, this perceived importance of politics makes sense. It is from that perspective we believe the road will become even more choppy as we move through the balance of 3Q (September). In the month ahead, action by Congress will need to occur on the topics of the US debt ceiling and a budget resolution. To the extent that the debt limit would not be successfully negotiated and a government shutdown occurred, the market would surely exhibit stress. While that risk should be and seems still remote, it feels equally challenging to entirely dismiss the potential for idealistic dysfunction despite the well-known self-destructive consequences.

From an economic perspective, the most clear message conveyed by data last week is that we are enjoying a period of synchronized global growth. Improving metrics around the world remain constructive and according to the IMF, in a way that has not been seen in a decade. Objectively and as reported by the WSJ this past Thursday, all 45 countries tracked by the Organization for Economic Cooperation and Development are on track to grow and 33 of those are poised for acceleration. Even here in the US the number of cities that are reported to be enjoying robust economic conditions is outstanding. And at the same time as growth is supportive, inflation remains tepid and a non-threat. This remains surprising when considering the degree to which monetary stimulus has been pursued over that same 10-year period; traditionally such a notable expansion of the monetary supply accompanied by economic growth might be assumed to produce problematic inflation. But the fact that inflation is yet to manifest continues to provide central bankers the flexibility to remove stimulus extraordinarily slowly and carefully.

While price inflation remains MIA, it would be hard to argue that central bankers have not achieved asset inflation. Asset inflation is visible through the levels of arguably most markets including housing, stocks, and bonds alike. From a valuation perspective, it is challenging to suggest that any asset class is cheap. It is in that regard, that the calls from market skeptics continue to call for the end of the bull market. This relatively pervasive notion probably best explains why money continues to flow out of equities in a way that is starkly different from what would be expected if investors were euphoric. But given the resiliency of the financial markets despite political noise, coupled with the observation that the President regularly likes to cite the performance of the Dow as a barometer for his success, might the stock market become the vigilante that gets Washington to focus on making progress on issues that have real fiscal significance? Will stock market vigilantes begin to exert pressure (via falling market) on Washington as we move into September? We think it might. In fact, one strategist is suggesting that should the stock market pressure via a more noticeable decline amid a sloppy political negotiation on the looming debt ceiling, it would be a buyable moment. While Trump and a partisan Congress seems deaf to criticism or wisdom in pursuit of achievements for the greater good, we have hope there is at least one vigilante left who can successfully get the message through: stocks. In the short-run, we suspect the market may get sloppy; but that may just be what the doctor ordered to incentivize leaders to get their act in gear and move forward with reforms that have the potential to extend the real business cycle.

Posted in Blog Post.