Yesterday I spent most of my day away from my screens, it was quite refreshing to be honest. As you are likely aware, the S&P 500 (SPX) had its first 1% plus decline in 109 trading days, a streak that we’ve only seen a few times in the past 50 years:
— Bespoke (@bespokeinvest) March 21, 2017
While one day does not make a trend, I think it is safe to say that the post-election rally was already losing steam. As we’ve written over an over again, a lot had to go right for the market to be able to sustain some of its post election assumptions. Here was how we phrased it on March 2nd:
What’s that mean? Investors are correct for now, stocks were a coiled spring. The economy is improving (mildly) and there’s an assumption that market friendly policy like corporate tax cuts and deregulation will happen and market harmful policies like trade wars and border taxes won’t.
We may be in a situation where an improving economy and a sideways market for the past few years is about to have kerosene poured over it. And the breakout could get absurd. But have a plan if it doesn’t. Because a lot has to go right for this to be sustainable.
And here’s an example of what what financial media focused on for the reasons behind yesterday’s sell-off:
Banks stocks have had a rough Tuesday as markets worried about how soon President Donald Trump would deliver on his pro-growth promises.
Our friend Peter Boockvar zeroed in even closer over at the Boock Report in a post titles “No Room for Error“:
While we’re all trying to find a reason (or reasons) for the market pullback we have:
- healthcare vote worries and tax reform legislation getting bogged down
- continued weakness in the Russell 2000 and transportation index
- financial stock weakness as the yield curve continues to flatten (the 3 month/5 yr yield spread is now 38 bps below the mid December peak and the smallest since mid November
I think maybe my #4 is most relevant today,
4. Kevin Brady’s comments on CNBC this morning before the market opened that “My sense is that border adjustability has become a given.”
The worst performing sector yesterday was bank stocks. The S&P Financials etf, XLF, was down nearly 3%. Why are bank stocks leading the broad market lower? First and foremost they were the most crowded trade in the market post-election, with the gains in the sector at one point this year amounting to more than 25% of the Dow Jones Industrial Average’s (INDU) gains since Nov 9th.
But why now? First interest rates, which failed to break out after the FOMC’s 25 basis point rise of Fed Funds last week, only its third hike in 10 years. Investors with large gains in the sector seem to be rethinking what the current yield curve means for net interest margins.
And obviously, the daily political brush fires in Washington are likely pushing out any meaningful changes to Dodd-Frank.
And Lastly, tax reform. Bank stocks, both moneycenters and investment banks, stand to be one of the prime beneficiaries of tax repatriation and lower corporate taxes (specifically, but also tangentially), as more cash in company’s coffers would lead to greater economic growth, spurring companies to deploy their cash for capex, acquisitions, buy back stock etc etc.
On Friday we detailed a bearish near-term defined risk strategy in the biggest under-performer in the mega-cap banking sector, Citigroup (Bank Turn?) and detailed it on CNBC’s Options Action:
— Options Action (@OptionsAction) March 21, 2017
This group should follow through in the coming days. The next thing to watch for as far as far as policy/politics is the Republican healthcare bill on Thursday. If it does not make it to the House floor or it does not get enough votes, Republicans will be scrambling to figure out where political capital is next spent, pushing on with healthcare reform or moving on. A decision to push on with healthcare reform could mean a massive push out of the market’s expected pro-growth policies.
And its not just banks, as I wrote about yesterday morning in this space, retail stocks have been getting hammered as it has become apparent that any meaningful tax reform will come with a border adjustment tax (and as Peter highlighted above) which would be very harmful to profit margins already squeezed by Amazon and Walmart.
Basic materials and Industrial stocks also don’t like the potential push out of potential tax credits (as discussed by those familiar to the administration’s plans). Technology companies would love to bring back their trillions from overseas at a 10% rate and healthcare companies just need a little bit of a clear message who they have to look over their shoulder for, Dems or conservative Republicans. Oh, and its not just financials that were looking forward to more de-regulation, you also have Energy companies:
The reason this does not turn on a dime, in my opinion, is that positioning and sentiment have been so one way since early November and it will take time for buy the dip habits to change. But suddenly the foundation of the bull case seems shaky at best. So I’ll book end this post by saying once again that one day does not make a trend. But it remains true that a lot of things have to go right just to maintain such lofty levels and justify current valuations.