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| MOBILE, AL - DECEMBER 17: President-elect Donald Trump speaks during a
thank you rally in Ladd-Peebles Stadium on December 17, 2016 in Mobile,
Alabama. President-elect Trump has been visiting several states that he
won, to thank people for their support during the U.S. election. (Photo
by Mark Wallheiser/Getty Images) |
In an increasingly tense world, why is Wall Street looking so sanguine?
From
a geopolitical perspective, 2016 has been the most volatile year in
recent history, with historic elections in Britain, Italy, and the U.S.
The election of Donald Trump as U.S. president has ratcheted up
anxieties, with the real-estate mogul recently saying that he planned to
“greatly strengthen and expand” the country’s nuclear capability,
raising the specter of a Cold War-era style
arms race.
However,
observers may be hard pressed to discern any signs of the swiftly
shifting political landscape in the equity markets. After
a rocky start,
trading this year was marked by a rally that has taken major indexes to
repeated records, but despite the tilt higher Wall Street has mostly
been marked by
a historic level of quiescence.
The CBOE Volatility index
VIX, +0.09%
a measure of investor anxiety,
recently fell to its lowest level since August 2015. According to LPL
Financial, the average level for the “fear index” in 2016 was below 16,
the fifth straight year it has averaged below 20, the level considered
its long-term average. Readings below 12 suggests that the market isn’t
betting on any sharp market swings.
Despite
that, investors are nearly unanimous that the events of the year have
injected huge amounts of uncertainty into the economy. It is unknown
what the fallout will be to the U.K.’s vote to exit from out of the
European Union, known as Brexit, or
the populist movements sweeping Europe. President-elect Donald Trump remains a wild card, as his tweets hint at
potentially massive changes to U.S. policy on China, in addition to calling out companies and Wall Street executives.
“The
world economy and markets have embarked on a journey into the unknown,”
researchers at Pimco wrote in a Dec. 15 note. The firm didn’t adjust
its outlook for 2017, but wrote that “our confidence in any particular
scenario is low. The reason: the world has now fully arrived in the
radically uncertain, ‘stable but not secure’ predicament.”
The
most commonly invoked aphorism on Wall Street is “markets hate
uncertainty.” So why hasn’t “a journey into the unknown” devolved into
wild price swings? Some analysts believe that we might get that at some
point—but not yet.
Perhaps the biggest question mark among geopolitical issue involves Russia.
On Monday,
the Russian ambassador to Turkey was assassinated by a Turkish police
officer, raising tensions that had already been elevated due to the
country’s
alleged hacking
during the U.S. campaign; Moscow has been charged with stealing and
leaking emails in an effort to interfere with the election in favor of
Trump.
While top Senate Republicans have joined Democrats in
calling for investigations into the issue, Trump has dismissed
intelligence assessments of the hack, raising questions about
the kind of response will be made by the government, if any.
“These
are really big wild cards. You hear guys like [Sen. Majority Leader
Mitch] McConnell saying that no matter what Russia did, they’re not our
friend. And then Trump comes out to say he’s a fan of Putin—that’s a
huge chasm, and we don’t know what side anyone is on,” said Michael
Mullaney, director of global market research at Boston Partners, which
manages $89 billion.
U.S. intelligence and Homeland security accused Russia of directing a series of cyberattacks to
influence the outcome of the presidential election.
“If
the election was tampered with, then there should be some kind of
retaliation, which would fly in the face of both Trump and Tillerson,
who is also very friendly with Putin. Those are significant curveballs,
and all they do is add more uncertainty to the market,” said Mullaney.
Mullaney was referring to Rex Tillerson, the chief executive officer of Exxon Mobil Corp.
XOM, -0.18%
who was recently named Trump’s secretary of state and has had business dealings with Russian President Vladimir Putin.
Despite
the uncertainty, equities have risen steadily since the election, with
investors betting that the broad outlines of Trump’s expected economic
policy proposals—which include massive corporate tax cuts, deregulation,
and heavy infrastructure spending—will accelerate economic growth and
spur inflation.
“Markets have factored in the prospect of lower
taxes. That’s the numerical rationale for these gains; it’s not just
euphoria about a business-oriented president,” said Kim Forrest, senior
equity research analyst at Fort Pitt Capital Group. “We’re not that
goofy, overall,” she said of market analysts.
Read: Wall Street’s Trump optimism comes with heavy dose of uncertainty
Trump
has released few details about the policies he will pursue, making it
difficult to evaluate their impact on the economy or corporate growth.
Thus far, however, corporate optimism doesn’t seem to match the
expectations conveyed by Wall Street’s rapid rise.
Nick Colas,
chief market strategist at the ConvergEx Group, recently noted that 2017
revenue growth estimates for Dow components had fallen to 4.5% from the
4.8% that had been forecast before the election.
“If history is
any guide, they will be trimming it further,” he wrote of company
analysts in a newsletter. “Moreover, our first look at 2018 revenue
[comparisons] for the Dow shows analysts expect top line growth to
decelerate further, to just 3.7% versus 2017.”
Don’t miss: Stocks get Trump bounce, but not the real economy
Even
if fundamentals don’t show signs of weakening, however, the prospect of
elevated tension with military rivals like Russia, or with major
trading partners like China or Mexico—both of which Trump has threatened
to levy tariffs on—could be enough to bring markets down.
“If
you look at headlines about our relationship with China getting choppy,
or the degree to which we may become buddies with Russia, or about how
Europe manages itself in this political age, then it’s easy to see why
we expect volatility will come back into this market,” said Bill Belden,
managing director at Guggenheim.
“The current lack of concern
seems to be that the dust will settle in a way that’s not too dissimilar
from what we have now, but even if that’s true, the path to the dust
settling is uncertain.”
