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The Dog That Did Not Bark: Why Isn’t The Market Reacting To Drama?

By Guest Post. Originally published at ValueWalk.

In thinking about the market over the past week or two, what has really struck me is how truly remarkable the market’s behavior has been. After the U.S. president implicitly threatened nuclear war, the market dropped, of course—but by less than 2 percent—and then it bounced back. Today, after CEOs from big-time companies essentially abandoned the White House, the market is down—but by less than 1 percent. We’ve seen more political drama in the past couple of weeks than we saw in years under some administrations—and the market is just sitting there. What’s going on?

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Henry Singleton

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As Sherlock Holmes would say, the real factor here is the dog that did not bark. The lack of reaction actually offers us meaningful information. There are two takeaways here:

  1. The market has shown resiliency in the face of events from Washington, DC, which implies that the underlying economic fundamentals are enough to keep it healthy.
  2. The lack of reaction suggests that political dysfunction is now fully assumed, which bodes poorly for future policy actions.

Resilience in the face of turmoil

With economic growth at levels consistent with last year, with employment growth and consumer confidence strong, and with retail sales bouncing back, the economy looks likely to remain on a growth path for a while. Corporate profits also have done very well—much better than expected—over the past couple of quarters, and it looks like this trend may continue. Plus, interest rates remain low.

All of the fundamental factors that have gotten the market to this level remain in place. The politics—given what we have already weathered—are not likely to disrupt them, at least in the short term. The American economy is like an aircraft carrier: it takes something pretty big to change its course.

Expectations for continued political dysfunction

This applies in the other direction as well, unfortunately. Much of the optimism that drove the market up after the November election was the expectation that the new unified Republican administration would be able to pass multiple business-friendly policies—to the benefit of the economy and the market. Some progress has been made, largely on the regulatory front, but major legislative action has not happened. Health care reform is dead, at least for the moment, as is any major infrastructure spending bill. Tax reform is the last outstanding possibility—and one where the market may still hold some hope.

As political dysfunction increases, though, that hope becomes increasingly dim. I have been saying for a while that hope is dead. Perhaps now it is shifting from dead to dead and buried. With Congress moving away from the president, passing anything as difficult as tax reform becomes even harder, and losing the White House as a motivator doesn’t make things any easier.

On the plus side, political news seems to have largely lost its ability to sink the market; expectations are simply too low. This means, though, that political news is also much less likely to boost the market.

Is this where we should be?

You could argue that we are exactly where we should be—that the market should react to economic factors, not political ones. I would agree with that, but with one caveat: this is not the road I would have preferred to travel to get here. You could also argue that this low expectation level provides an opportunity. If tax reform were to pass unexpectedly, for example, the market reaction would be all the stronger. I would agree with that as well, but with two caveats. First, that’s a big “if.” Second, while we can hope for good news, bad news is also a possibility, with the debt ceiling taking first place in that category.

So, what’s the big picture?

Assuming we get past the debt ceiling debate (which we will), the market will probably continue to discount politics and move on economics. Although we will certainly see more headlines from DC, the economic news is likely to continue to be positive, which should keep the market moving more smoothly than the headlines would suggest.

Article by Brad McMillan, Commonwealth Financial Network

The post The Dog That Did Not Bark: Why Isn’t The Market Reacting To Drama? appeared first on ValueWalk.

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