Equity investors have been on a ride in the past weeks, as volatility measures hit record lows. This rally which has been nicknamed the Trump Bump. On Wednesday we had a bit of a Trump slump as the S&P 500 fell almost 2%. Its worst day for over 8 months. The announcement that a special council has been appointed to investigate the existence of any links between the Trump administration and the Russian Government being the catalyst and shake investors apparent complacency to the political developments in America. There was a true flight to safety as bond and gold prices rose and the Vix index jumped almost 50% in one day. The markets are drawing comparisons that the appointment of a special investigator which led to the downfall of Nixon. Even if this is not the ultimate outcome the prospects for tax reform, the trillion-dollar infrastructure spend program and the amendment of the healthcare bill have become a lot less likely. It is worth reminding ourselves how strong equities have been and a correction is always on the cards after such stellar performances. What is also worth noting is the recent relative strength of the FTSE 100 in comparison to many developed markets as the pound too has remained resilient.
As always, the question investors ask themselves at these points. Is this a healthy correction after a strong run or the start of a greater correction? Equity sentiment, according to a Merrill Lynch report has moved into euphoria territory. This conclusion is based on measures such as the put/call ratios, investor surveys, price technical and volatility. On the other hand, yields on bonds continue to suggest a degree of fear, or perhaps equity investors are ignoring what the bond market is telling it.
Strong rallies with no corrections are not generally healthy, one can go back to 1987 to be reminded of that. It can lead to complacency, and overstretched valuations. Corrections give the markets the opportunity to sort themselves out, its where the opportunities come.
With June fast approaching the Federal Reserve may well have been making part of their interest rates assumptions based on the expectation of the impending tax reforms. The likelihood that these will not come to pass, at least in this year, could now skew the Federal Reserve’s thoughts. Indeed, the bond market was pricing in a near 100 pct. chance a few weeks ago, the odds are now looking closer to even money.
Last month saw a surprise recovery in retail sales in the UK. After the recent slump in sales this is possibly evidence that the UK economy is showing signs of resilience. This better than expected piece of news ensured the pound went through the 1.30 to the dollar.