Every once in a while, investors seem to catch a glimpse of the unique risks posed by President Trump — and they panic. It happened Wednesday, when the scandals embroiling the White House sparked the biggest market downturn since September, including a 1.8 percent drop in the Standard & Poor’s 500 and a rush to safe harbors like bonds and gold.
Quickly enough, though, investors manage to steady their nerves, straighten their hair, and get back to acting as if all is right with America. Hence Thursday’s mild recovery.
Is it denial or wisdom, this general calm in the face of so much D.C. Sturm and Drang? That’s been the question ever since the election of Donald Trump sparked a surprise rally in the markets. And six months into his tumultuous presidency, it remains a puzzle.
Particularly so in the stock market. Elsewhere, there’s been a slow-but-steady paring back of Election Day optimism; the dollar, for instance, has been weakening over time, and yields on longer-term Treasury securities have fallen in the past week.
But for some reason stock markets continue to shrug off the fact that more and more people are using the word impeachment.
Maybe it really is wisdom. With so much money on the line, it would be madness for equity investors to willfully ignore the risk of a political meltdown. They have a strong, wallet-filling incentive to gather the best available information and act on it. Not even news organizations can claim such a direct link between getting the story right and making money (sometimes, sensationalism sells).
And if you take the long view, it’s not unreasonable to think that Trump’s agenda will boost the profitability of American businesses — to the great benefit of investors. Above all, if Congress passes anything like Trump’s multitrillion-dollar proposal for business tax cuts it would undoubtedly goose the bottom line of many US corporations.
Nearly as good, Trump seems to have dropped his riskier antitrade promises. Last month, he decided not to label China a currency manipulator, after which he agreed to renegotiate the US-Canada-Mexico trade deal rather than scrap it. Both acts brighten the economic future by reducing the risk of a costly trade war.
And yet, there is still this problem: What if we are headed toward a Watergate-level scandal, the kind of thing that could undermine trust in US institutions, encourage desperate acts of face-saving from the White House, and stop the government from handling all the routine, matter-of-course activities that a working economy requires?
Such a scenario may still seem unlikely, but it’s more likely today than it was last week — and a lot more likely under Trump than it was under Obama or Bush. Political betting markets give Trump just a 60 percent chance of remaining in office until the end of 2018 (whether because of impeachment, resignation, or death.)
How is this not being reflected in stock prices? Or even the so-called VIX fear index, which measures expected volatility and which remains relatively subdued despite a mid-week jump.
Markets are notoriously bad at pricing in this kind of risk — the unlikely but potentially catastrophic events known as tail risk. And it was an inattention to just this kind of small-but-snowballing danger that helped propel the financial crisis of 2007-2009.
That leaves us with two possibilities. Either equity investors are proving themselves wise enough to look beyond the frantic news cycle, or too blind to see the potential fallout. But which one?
Here’s the great thing about markets. If you think you know the answer, you can do more than just mount an argument: you can mark your ideas to market, betting long if you believe in a brightening future, or selling short if you foresee a coming collapse.