Corrected: It’s Senate Majority Leader Mitch McConnell.
I can’t remember a single time in recent years when the stock market, the economy, politics, and investors’ behavior were less in sync.
On Friday, the second revised GDP report for the first quarter of 2017 showed a 1.2% annual real increase—double its first estimate of 0.6%, but still pretty feeble. Meanwhile, durable goods orders dropped 0.7% in April, a bad sign for the second quarter but in line with the weak “hard” economic data I wrote about in my MarketWatch column this week.
Yet The Dow Jones Industrial Average, Standard & Poor’s 500 index, and Nasdaq Composite index rose six days in a row through Thursday, and the latter two again hit record highs.
So, how did investors react? They sold $3.3 billion worth of U.S. stocks this week, according to Bank of America Merrill Lynch, after having unloaded $9 billion last week. Maybe they’re selling on the good news, but I doubt it: According to the Investment Company Institute, they’ve been pouring money into underperforming foreign stocks, particularly emerging markets, for years.
And the prospects in Washington for health care reform, tax reform, and infrastructure (key pillars of the Trump rally) are fading.
How do we sort this all out?
Well, first of all, the economy doesn’t drive stock prices; earnings do, and first-quarter earnings grew almost 14% over 2016’s first quarter. That was the best earnings growth in 5 ½ years, and three out of four companies in the S&P 500 beat Wall Street’s earnings estimates.
Also, the Federal Reserve has laid out its roadmap for interest rates: two more ¼-point increases in the federal funds rate in 2017 and a very slow winding down of it $4-trillion-plus balance sheet. Investors are pretty comfortable with that, and rate hikes won’t likely choke off the recovery until at least next year.
But it’s becoming clearer that not much is likely to come out of Washington, D.C. this year. Senate Majority Leader Mitch McConnell (R-Ky) said this week he doesn’t know how he’s going to get the bare minimum 50 votes to pass any health care reform bill in the Senate. The prospects for tax reform look a little better, but they’re still a stretch: With its interminable recesses, Congress will barely have enough time to extend the debt ceiling (remember that?) and keep the government from shutting down.
So, we’re left with a stock market hitting all-time highs in a middling economy with weak investor confidence and a cloudy outlook for the political changes that drove the market higher in the first place. With the S&P trading at 17.6x this year’s projected earnings, I’d suggest holding what you have and not buying more, while keeping one eye on the exit.