by Liz Ann Sonders, Senior Vice President, Chief Investment Strategist, Charles Schwab & Co
We say goodbye to the first half of a tumultuous, but rewarding, year and look ahead to the second half to see what might be in store for the U.S. economy and stock market. I travel all over the country speaking with our investors, and a dominant topic—and concern—is about rampant U.S. government and monetary policy uncertainty and why it has not had a deleterious impact on the stock market. Perhaps it just hasn't had an impact yet. Or perhaps there are forces underpinning this bull market that supersede the political turmoil.
Let's start with the political environment. No one can deny a level of partisan rancor that exceeds anything witnessed in the past several decades. But is that necessarily the death knell for stocks? Not historically. The first chart below is a six-month smoothing of the Philadelphia Fed's "Partisan Conflict Index" and the second is a table highlighting that stocks have risen faster—much faster—when partisan conflict has been elevated on an absolute basis and relative to the recent past.
Source: Federal Reserve Bank of Philadelphia, Ned Davis Research (NDR), Inc. (Further distribution prohibited without prior permission. Copyright 2017(c) Ned Davis Research, Inc. All rights reserved.), as of May 31, 2017. Partisan Conflict Index tracks the degree of political disagreement among U.S. politicians at the federal level by measuring the frequency of newspaper articles reporting disagreement in a given month.
What the data highlights above is the key tenet of the "stocks like to climb a wall of worry" mantra; just in a different form than traditional investor sentiment.
But what about pro-growth policies?
With continued delays by the Trump administration and Congress on its healthcare reform progress, tax reform and other perceived pro-growth policies are getting pushed further out. To date, this has not had a significantly negative impact on stocks; possibly because estimates have not yet been raised for either corporate earnings or overall gross domestic product (GDP) growth.
The hope around policy did have a positive impact on "soft" economic data, which are survey- and confidence-based measures—they surged post-election but have recently been in retreat. I continue to believe the spread between the soft and hard (actual) economic data will narrow with the soft data continuing to catch down to the hard data, until we get more clarity on pro-growth policies' timing, especially tax reform.
As an aside, I was privileged to sit on President Bush's bipartisan nine-member tax reform commission in 2005, so got to see the inner workings of trying to push reform through. Let's just say it's not easy. I will share that I think tax reform would be great for the economy and markets; tax cuts (without true reform) would be less good, and tax cuts that sunset (i.e., are temporary) would not be good.
The aforementioned soft/hard divide helps to explain the dramatic fall in the U.S. Citigroup Economic Surprise Index, which measures how economic data is coming in relative to expectations and can be seen in the chart below. The plunge has been less about U.S. economic data deteriorating, but instead about the expectations bar having been set too high (higher confidence brought higher expectations). I believe the CESI is bottoming as the expectations bar has gotten set lower. A higher trending line is to be expected, at least in the early part of the second half of the year.
Source: FactSet, as of June 30, 2017.