As Trump's woes deepen, Wall Street pulls in its horns

The political fortunes of President Donald Trump and the stock market are inextricably linked. And, clearly, both are currently experiencing setbacks as the catalyst for the post-election rally to record highs -- a market-friendly legislative agenda including tax cuts, deregulation and infrastructure spending -- come under threat.

Stocks were hit with their largest decline since last September as the Trump administration battles a deepening crisis involving alleged ties between his campaign and Russia and Mr. Trump's decision to fire FBI director James Comey. The U.S. Justice Department on Wednesday named former FBI chief Robert Mueller to look into the matter.

Reuters reports that the Trump's campaign had at least 18 undisclosed contacts with Russia. As the president's woes deepen, so too does the threat to Wall Street, with bank stocks in particular looking vulnerable.

There is some irony in all this. Before November, the conventional wisdom up and down the Street was that a Trump victory would be a negative for financial markets because of his anti-establishment views, vows to crack down on immigration and protectionist leanings on trade. 

After the Election Day upset, and a short-lived decline in the futures market, investors only wanted to see the positives. As a result, the Dow Jones Industrial Average gained more than 19 percent, hitting a new high in early March. The tech-heavy Nasdaq Composite did even better, shooting up nearly 23 percent into a high set earlier this month.

The optimism fueling this rise, however, was not justified, as the latest economic and corporate data is showing. 

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The "hard" activity-based economic data has been weak for months, but now even survey based "soft" data is rolling over, absolutely crushing the Citigroup Economic Surprise Index shown in the chart above. The bond market also has been warning of trouble, with the U.S. 10-Year Treasury Yield declining from a mid-March high of 2.62 percent to a low of 2.18 percent in the middle of April.

Technical measures suggested frothy sentiment was responsible. On a cyclically adjusted price-to-earnings ratio, the only time when stocks have been more expensive was heading into the 1929 and 2000 market bubble peaks. Breadth -- or the number of stocks participating to the upside -- has been narrowing as bullish investors focus on fewer and fewer issues (mainly, banks and big-tech stocks) to push the major averages higher.

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Meanwhile, both Wall Street's weakness and Trump's political headaches look like they are just getting started. The percentage of S&P 500 stocks in uptrends broke below its six-month range, dropping to 69 percent versus a high of 80 percent in March. Yet the S&P 500, at least for now, remains within the confines of a four-month trading range.

By this measure, stocks should return to levels last seen in December. That would take the Dow back below the 20,000 level, a loss of more than four percent.

While a pullback of that magnitude doesn't sound so bad -- call it a pause that refreshes -- the pain will likely be more acute for specific areas of the market that surged on Trump's election win.

Big banks look vulnerable as the Financial Select SPDR (XLF) gained nearly a third 
from its November low into its March high in anticipation of higher profit margins from "Trump-flation" -- that is, higher inflation, higher economic growth and higher long-term interest rates -- as well as hopes of a tailwind from deregulation given the White House's desire to roll back Dodd-Frank reforms

  • Anthony Mirhaydari

    Anthony Mirhaydari is founder of the Edge , an investment advisory newsletter, and Edge Pro, options newsletter. Previously, he was a markets columnist for MSN Money; a senior research analyst with Markman Capital Insight, a money management firm; and an analyst with Moss Adams focusing on the financial services industry.