By Randall W. Forsyth
The Trump rally in the stock market stumbled this past week, in no small part owing to the president-elect's controversial appointments to the incoming administration.
After hitting a record just over 6000 on Monday, the S&P 500 index shed a little more than 2% this past week, with a 1.3% drop in Friday's session. The tech-dominated Nasdaq Composite fell even more sharply, losing over 3%, while the Dow Jones industrials managed to lose only 1.2%.
As my ever-perceptive colleague Andrew Bary pointed out, the market stumbled after the announcement of President-elect Donald Trump's controversial nominations of Florida Rep. Matt Gaetz for attorney general, former Hawaii Rep. Tulsi Gabbard to head intelligence services, and Robert F. Kennedy Jr. to run Health and Human Services. From the pure dollar-and-cents calculus of the financial markets, the all-but-certain fights over these names threaten to scuttle, or at least slow, the pro-growth initiatives that were behind the Trump rally.
"The markets like predictability and stability, and Trump has delivered neither in the last 24 hours," wrote Greg Valliere, the veteran Washington watcher and chief U.S. policy strategist at AGF Investments, in an email on Thursday. "Is he looking for the best possible people, or does he want to send a message to his rivals? If it's the latter, we're in for a long four years."
No need to waste space detailing accusations against Gaetz, other than that the chances of his confirmation are already dimming. Odds of the Senate approving his nomination were only 29% on Polymarket, the betting site that was far more prescient than pollsters in predicting the presidential vote.
The most important takeaway from these D.C. doings, at least from the markets' unemotional perspective, is that they threaten the new administration's ability to pass tax legislation in the first half of next year, according to a research report from Strategas' ace Washington policy analysis team led by Daniel Clifton.
The loss of three members of the House of Representatives -- Gaetz; Rep. Mike Waltz, also from Florida (tapped as national security adviser); and Elise Stefanik, from New York (for United Nations ambassador) -- could eliminate the two- or three-seat GOP majority in the House temporarily, they wrote. The Strategas team doesn't expect Florida to hold special elections to replace Gaetz and Waltz until May, while in New York the governor has up to 90 days to set an election.
"The net effect is that the Republicans might be delayed in moving forward on tax legislation unless every member agrees with every provision of a $4 trillion package," says the Strategas team, referring to the renewal of the Tax Cuts and Jobs Act, which expires at the end of 2025. The GOP would probably want to pass an extension of the TCJA in the first half of 2025, before an increase of the debt ceiling, the suspension of which ends on Jan. 1, to maintain certainty for consumers and businesses.
The more mundane matter of rising bond yields also weighed on stocks. The 10-year Treasury note hit the 4.5% mark on Friday, which proved nettlesome to equities in the past. That was up 88 basis points (hundredths of a percentage point) from its recent low in mid-September.
There have been two big changes in the bond market's perspective: the increased recognition of the impact of the budget deficit, and, while the economy is perking along nicely, inflation isn't receding further. The Federal Reserve Bank of Atlanta's GDPNow shows inflation-adjusted annual growth estimated at a 2.5% annual rate in the current quarter, roughly in line with the third quarter's preliminary estimate of 2.8%.
Meanwhile, progress in reducing inflation has stalled. John Ryding and Conrad DeQuadros, economic advisers to Brean Capital, note that core consumer prices (excluding volatile food and energy) rose by 0.3% for the third straight month in October. That brought the 12-month rate to 3.3%, the same as in June and significantly above the Fed's 2% inflation target.
Adding to the upward pressure on bond yields was Fed Chair Jerome Powell's comment on Thursday that monetary authorities don't need to be in a hurry to lower their short-term interest target. "The strength we are currently seeing in the economy gives us the ability to approach our decisions carefully," he said at a Dallas Fed symposium.
That contrasts with the double-quick 50-basis-point cut in September, when the Fed initiated its rate reductions, followed by a more typical 25-basis-point reduction the week before last. But the probability of a similar trim in December has slipped substantially, to 58.4% on Friday from 64.6% week ago and 85.5% a month earlier, according to the CME FedWatch site.
This Fed easing looks premature and recalls a similar episode in 1966-67, according to a research note from Macro Intelligence 2 Partners. Then, the Fed reversed its previous aggressive tightening following turbulence in the banking sector and a tumble in stocks. The easing, combined with the fiscal stimulus of the guns-and-butter policies of the Johnson administration, set off waves of inflation that surged through the 1970s.
Rising stock prices and bond yields means the equity risk premium has dwindled to almost nil, according to a Rosenberg Research report. That leaves no margin of safety for investors as they confront a less certain political future than they anticipated after the GOP sweep just a few weeks ago.