Once in a while, a single week seems to perfectly illustrate the main forces in markets. Last week did just that for stocks, highlighting two sets of competing influences that are unlikely to dissipate any time soon and have important investment implications.
The day after the U.S. midterm elections, Nov. 7, was the most notable of last week’s swings. The Dow Jones Industrial Average was up more than 500 points, or 2.1 percent, the Nasdaq Composite rose 2.6 percent, and the S&P 500 Index gained 2.2 percent.
The immediate cause of the rallies was the split Congress that emerged as Democrats gained control of the House of Representatives and Republicans increased their majority in the Senate. Conventional wisdom holds that such a divided outcome tends to be good for markets as gridlock keeps the government on the sidelines, allowing businesses to do what they do best: pursue profitable opportunities without undue interference from new legislation and regulation.
There were also powerful economic forces at play in the markets. The U.S. economy continues to move forward, powered by three simultaneous and self-reinforcing engines:
-Consumption (driven by strong labor markets, tax cuts and the positive sentiment confirmed by data from the University of Michigan survey on Nov. 9).
-Business investment (reflecting favorable corporate sentiment, high cash balances and deregulation).
-Fiscal stimulus (especially as government spending increases and a spilt Congress is unlikely to scale back outlays or roll back the recent tax cuts).
President Donald Trump’s comments the day after the election that he would “like to see bipartisanship” opened the possibility that this growth spurt could be reinforced by progress in Congress on an infrastructure modernization initiative.
This favorable economic outlook for the U.S. was offset in markets by two factors that caused the Dow to decline 0.8 percent on Nov. 9, the S&P to fall 0.9 percent, and the Nasdaq to lose 1.7 percent.
The first downward force is that economic activity outside the U.S. continues to slow, making some large debts even more burdensome. This was illustrated by more data out of Europe last week and by a stark warning from China’s central bank about the “profound changes” facing its economy.