Is the stock market ignoring one of the most important risks of 2017?

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)

Many questions remain about Trump’s policies and geopolitical aims

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.

Read: Delayed reaction? Here’s when the latest terror attacks could rattle markets

See also: How Trump and Brexit are shaking up investment portfolios for 2017

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.

Read: Wall Street’s ‘fear gauge’ implies that few are prepped for a stock-market shock

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.”

Ref.: http://www.marketwatch.com/story/is-the-stock-market-ignoring-the-most-of-important-risks-of-2017-2016-12-23


 

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Cherry May Timbol – Independent Reporter
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