It’s always easy to blame what’s happening in financial markets on the biggest headline of the day. Yes, a 373-point drop in the Dow Jones Industrial Average is attention-grabbing. But simply blaming it on the political noise from Washington may be too easy.
For one, a 300-plus-point drop can hardly be called a reversal when the index has surged more than 3,000 points since the election.
Also, consider that market watchers have been drawing attention to overextended market valuations for a while, which suggests anything could have triggered a broader selloff — whether it’s political noise, a bad earnings report, or a global event. The Dow surely would have lost a lot more had Marine Le Pen won the French presidential elections earlier this month.
It seems extremely premature to write-off expectations of a more business-friendly turn in U.S. fiscal policy. The potential for substantial tax relief is in peril not because of turmoil in the White House but because of congressional Republicans’ inability to square the circle of promising tax cuts and debt reduction simultaneously.
President Trump has not been leading the debate on tax reform; House Speaker Paul RyanPaul RyanCBO score of GOP health bill to be released Wednesday Will McConnell and Ryan put party over country in defense of Trump? Ryan: More audio leaks ’cause for concern’ MORE (R-Wis.) has, and he is facing opposition in his own party. Once Ryan can square that circle, Congress will proceed with the Republicans’ fiscal agenda to strengthen their chances in next year’s midterm elections. Meanwhile, the rollback of business-unfriendly regulation continues, which we believe will have the bigger impact on U.S. economic growth in the coming years.
The real question isn’t whether the market selloff is Trump’s fault, but why investors kept buying U.S. equities. Valuations were known to be high, the Trump administration was demonstrating that it was anything but a well-oiled machine, and underlying economic fundamentals were extremely volatile. The case for equities rests on two arguments that aren’t changing with the increase in political noise.
First, global markets are still holding an enormous excess of liquidity and are not providing enough return for holding cash. So, many investors are still forced to choose between overvalued equities and equally overvalued bonds. But if liquidity were the only factor at play here, more investors would opt to stay on the sidelines waiting for a broader market correction.
That brings us to the second argument: Amid evidence of a more synchronized global economic recovery, equities allow investors to gain from improving fundamentals. That growth trend is driven by a rebound in global business investment, which was prompted by a shift from global excess supply that was deflationary and depressed investment to demand and supply that is more in balance.
We see evidence of such a regime change in stronger investment spending in the U.S. and Europe, rising capital goods exports in Asia and increasing industrial metals prices in Latin America. In the clearest sign yet that more optimistic growth expectations are finally being validated, the International Monetary Fund has upgraded its growth forecast for 2017.
Political noise can briefly shake up investment flows, especially in overvalued markets. But unless the turmoil in Washington affects spending and investment behavior in the U.S., growth expectations — which depend more on the rollback of regulations than on the brief sugar high of tax cuts — will continue to improve. This means scared sellers of U.S. stocks will find eager buyers, ensuring that sell-offs like this week’s will not last long.
Markus Schomer, CFA, is the chief economist at PineBridge Investments, a global asset manager with offerings that span the asset class and capital structure spectrum.
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