After falling dramatically last Wednesday in reaction to concerns about political setbacks and controversies in the nascent Trump administration, the equity markets rebounded nicely on Thursday and Friday and all the major domestic indexes are near all-time highs. While volatility briefly spiked, the widely followed VIX index (a measure of expected future short-term volatility) is trading near the low end of its historical range.
Is rising political uncertainty congruent with optimism in the financial markets, or is there a fundamental disconnect between the political world and investment markets?
Residents inside the beltway likely believe that the political turmoil in the Nation's Capitol portends ill for future financial market returns. With the specter of the "I" word -- impeachment -- rising, some pundits suggest a rocky road for stocks and believe investors would be wise to enact a "risk off" strategy.
Certainly a fundamental market tenet is that markets dislike uncertainty. But, what many fail to realize is that markets prefer uncertainty over certainty if the certain path is one investors abhor. The markets didn't rise following the election of Donald Trump because investors embraced Donald Trump, they rose because of optimism of a business-friendly Republican agenda. In fact, Wharton Professor Jeremy Siegel recently posited that the Dow could potentially rise 1,000 points if Trump was removed from office. The rationale is that a nearly identical agenda would be pursued without all the attendant drama.
Recent political events in the United States and abroad are testing both the patience and resolve of investors. Many investors believe that the events are so profound that they warrant some sort of response via portfolio adjustments.
Recent stock market strength is not a response to political occurrences, but to market fundamentals, specifically corporate earnings and interest rates. According to Thomson Reuters I/B/E/S, first-quarter profits for the S&P 500 are on pace to rise by 15.2 percent. This would be the best quarterly performance in six years.
In addition to strong earnings growth, interest rates remain near historically low levels. At the most recent Berkshire Hathaway meeting earlier this month, Warren Buffett said that investors would do well if the 10-year Treasury yield stayed near current levels for ten years. In fact, Buffett said if interest rates remained low, stocks were actually on the cheap side. The bottom line is that the combination of rising corporate profits and low interest rates is a winning one.
It is important for investors to not get distracted and to sort out the signals from the noise in making investment decisions. Earnings are sending a strong signal. Often political commentary, especially in advance of actual policy, is little more than noise.
Investors old enough to remember Mad Magazine's Alfred E. Neuman may want to adopt his iconic slogan, "What, Me Worry?" It seems appropriate for the current financial market environment.