I had President Trump’s February 28th speech to Congress circled on my calendar for a few weeks. Yesterday, I stated it was bullish for the market because of its positive tone. Unity was promoted. Unity in government means more bills will get passed. In the past, the market has been in favor of gridlock because the market was afraid legislation which hinders growth would be passed. However, in the current scenario, the market is expecting pro-growth laws, so it wants bills to be passed swiftly. The other positive was the promise to avoid petty arguments. When Trump tweets something negative about a company its stock falls which adds to the uncertainty investors have. Eliminating this practice is a win for all stocks.
While I acknowledged it was a bullish speech yesterday, I didn’t favor its lack of details on specific policy initiatives. There was a concerted effort to avoid offending any factions which means no divisive policy proposals were made. It sounds great to unite the government, but every policy is inherently divisive because of differing opinions and constituencies. Getting anything passed will take debate which gets polarizing at times. Usually the market likes specific details because they give clarity, but this market seems to be turning many beliefs which were conventional wisdom on their heads.
Some bulls are claiming to like the general nature of the speech because it means the stock market party can keep going without the details. Investors can simply imagine in their heads what they believe is the perfect scenario and apply it to how they value stocks. This ‘ignorance is bliss’ argument is a function of the market’s optimism, but doesn’t represent reality. When stress comes back to the market, it will once again call for specifics on how the problems will be solved. As an investor who has discipline, it’s important to not take this line of thinking because it’s illogical. Evidence should always be valued over hope.
The speech which lacked details has become a game changer for the market as the initial tepid response after-hours was replaced with an over 300-point rally in the Dow. The S&P 500 is now up 7% year to date. If the market went up 7% every two months, it would be up over 40% for the year. The VIX was down almost 4%. I had stated the VIX could not continue rallying along with the stock market. The two have finally decoupled as the unsustainable trend ended.
Stocks have been rallying the entire year, so the reason why I say today’s action in the markets is a game changer is not because of its rally. In an article a few days ago, I had discussed my confusion with the bond market. The Fed is raising rates, stocks are rallying, and inflation is rising. How could the 10-year bond be rallying in the face of this news? Usually the fixed income market should be trusted over stocks, but in this case I was doubting that conventional wisdom because it was acting against many other forces. I stated that one of the reasons for the rally was because short treasury trades were unwinding. Regardless of what caused the rally, it appears to be over. The 10-year treasury yield is up from 2.3117% on February 24th to 2.4544% today. It’s still about 18 basis points away from its December high, but I would no longer call the action perplexing.
While I was correct to focus on President Trump’s speech today well in advance and I was correct to say it was positive, I have been proven to be off-base in my assertion that the March Fed meeting would not be a ‘live’ meeting. The odds for a Fed rate hike in March were low a few weeks ago; I thought it was impossible to have such a big change in opinion in such a short time. This big change is exactly what we have witnessed as the CME Group website has the odds jumping from a 35.4% chance of a rate hike to a 66.4% chance of a rate hike.
For the first time in this cycle, the Fed is now back on its initial schedule as the guidance for 3 rate hikes in 2017 looks achievable. The equities market has changed its tune on rate hikes as it now rallies in response to them. In fairness, the market rallies in response to everything, so it’s difficult to discover the variable which is causing such optimism. Either way, one of the premises I proposed for why the market isn’t selling off at the hint of rate hikes was because the market hadn’t been vacillating between various policy expectations. This has been proven incorrect because the market just changed what it’s expecting and the stock market still rallied despite this change.
I have discussed at length the decision about whether the Fed would front-run Trump’s fiscal policies or wait and see what effects they have on the economy before acting. There is now no question the Fed will be front-running the stimulative measures being passed. This is dangerous because I’m sure there will be times in the he next few months where it doesn’t look like tax reform and healthcare reform will be passed. Congress always likes to make things interesting. Virtually every industry has something riding on these new policies, so passing them won’t go smoothly. The Fed has gone from hoping Congress will boost growth, to expecting it to purely based on Trump’s positive rhetoric and the optimism expressed by the consumer and small businesses. If it looks like the Congress won’t pass anything, the market could fall which would only add pressure to the situation.
Conclusion
I understand the bullish case for stocks is that regulatory cuts and tax cuts will boost growth. This is a realistic opinion to have. Personally, I am fearful why everyone is greedy, but I understand the argument. What I don’t understand is how a lack of clarity can be considered good news. The narrative is to not care about the details. If a company stated it was going to make a profit sometime in the future, but didn’t specifically say how it would do that, normally investors would balk at the stock. However, in this market stocks which lose money, but supposedly have a bright future are rewarded with high multiples. The most obvious example of this is Snap’s $20 billion IPO which is expected to start trading tomorrow.