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The market hit a snag last week as President Trump‘s Russia troubles seemed to spiral out of control. The Dow sank 370 points on Wednesday and appeared poised for more pain. Yet, by Monday, most of the losses had been erased.
As in the movie “Groundhog Day,” this pattern seems to be repeating itself on a continual basis.
And unless President Trump’s personality changes fundamentally, an event which is highly unlikely, the pattern of volatility that we are experiencing will continue for the foreseeable future.
But, is this the end of the Trump rally and beginning of a new bear market?
Trump’s troubles have been compared to the Watergate scandal of the Nixon administration and the severe 1973-1974 bear market that resulted. But at the moment, the Whitewater and Lewinsky scandals of the Clinton administration and the continuing bull market may be the better comparison.
In both instances, we had almost daily revelations about the president’s misdeeds and quite a bit of market volatility. However, the market outcomes were quite different. Why? In the words of James Carville, the Clinton political strategist, “it’s the economy, stupid.”
The economic conditions of the two scenarios could not have been more different.
The Nixon administration was suffering from rampant inflation from the Arab Oil Embargo and the most severe recession since the Great Depression. There were gas shortages with rationing based upon the odd and even numbers of license plates. Unemployment was rising.
The Clinton administration experienced almost a reverse version of these economic conditions. Inflation was moderate, and unemployment improving. With the end of the Cold War and the dissolution of the Soviet Union, the United States was now the sole superpower of the world.
The rising uncertainty that we have been expecting following the brief Trump honeymoon has intensified. Since equity markets dislike uncertainty, it has been extremely difficult for them to make any progress.
Yet, much of Trump’s disruptive rhetoric and actions on social issues have few implications for the domestic economy and financial markets. In terms of economic and financial issues, many of Trump’s positions will favor a particular asset class, sub-asset class, or sector at the expense of another but not necessarily portend a more serious market downturn.
As long as inflation remains benign and the Federal Reserve does not accelerate its gradual tightening course as indicated in the recent FOMC statement, the equity rally may pause or see minor corrections, but should ultimately move slowly upwards. That said, one of these shocks could trigger a major correction:
- Black Swan from global economic deterioration
- Mideast oil disruption leading to price spike
- Black Swan from trade war
- Accelerated FOMC tightening in face of U.S. economic weakness
The first three events listed are geopolitical in nature and are threats that could spiral into something quite severe because they could become something that is largely beyond the control of the U.S. government. The 2008 financial crisis was triggered by an offshore subsidiary of AIG and largely came as a surprise to then Federal Reserve Chairman Ben Bernanke.
The last two events refer to policy mistakes made by the U.S. government. It is quite true that the current Russia investigations could derail the much of the president’s legislative agenda. However, President Clinton was able to deliver much of his agenda despite the impeachment controversy of his administration.
Trump’s executive orders and trade negotiations seem to continue to be effective in stimulating economic growth at least in the short term, as illustrated by promised domestic investment by China and Saudi Arabia. Questions remain whether this can carry on in the long run absent legislative cooperation. However, in terms of the influence on the financial markets, one must remember the famous saying by British Economist John Maynard Keynes, “In the long run, we are all dead.”
It is possible that the FOMC could tighten in the path of severe economic weakness. Thus far, it does not appear likely. The Federal Reserve remains committed to a policy of tightening but appears to have no catalyst to accelerate the process.
Even so, a return to the blistering Trump rally is unlikely unless the sources of uncertainty overseas are resolved to some degree or until the president’s legislative agenda is enacted to some degree. Instead, we will see a sideways market or at best a slow grind upwards towards the end of the year. Expect a 2 percent to 3 percent increase by the fall.
Commentary by Douglas Roberts, managing director of Channel Capital Management, LLC and Founder and chief investment strategist for the Channel Capital Research Institute, LLC, an independent research firm focusing on investment strategies using the Federal Reserve’s impact on the stock prices. He is the author of Follow the Fed® to Investment Success. He has been an adjunct professor at the Leon Hess School of Business at Monmouth University in New Jersey and also previously held executive positions at Morgan Stanley Group and Sanford C. Bernstein & Co.
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