Investors hate uncertainty, and there’s been a lot of it to hate this year: mounting worries over trade, the Federal Reserve’s shifting stance on interest rates, Brexit, US consumer confidence, and whether the Chinese government can reignite the country’s economic growth.
Still, stocks started the week not far from their July peak, and the CBOE Volatility Index, a.k.a. the “fear gauge,” hadn’t shown much fear.
But Wall Street’s surprisingly sanguine mood is about to get tested.
On Tuesday, House Speaker Nancy Pelosi announced a formal impeachment inquiry of President Trump, yielding to pressure from fellow Democrats after he allegedly tried to get Ukraine to open a probe into former vice president Joe Biden, a leading challenger for president, and Biden’s son, Hunter.
Pelosi’s bombshell followed the release of a report that showed the biggest drop in consumer confidence in nine months, weak manufacturing data for the mid-Atlantic region from the Richmond Fed, and tough talk by Trump on China that once again reduced hopes for a quick resolution of the tariff war.
It was a day of unexpected turns that upset the relative calm that had settled over the market in recent weeks. In a turbulent session, the Standard & Poor’s 500 index fell 0.8 percent, its biggest decline in a month.
The fear gauge spiked 14 percent.
The market had largely ignored the investigation by special counsel Robert Mueller into Russian interference in the 2016 election and Trump’s efforts to obstruct it. And the Democrats’ decision to take the first major step toward impeachment won’t itself send stocks into a protracted slide; recall that stock prices continued to climb throughout the Clinton impeachment investigation and trial in late 1998 and early 1999.
But investors now have yet another wild card to worry about.
“I really don’t think it matters, because there aren’t the votes in Senate to convict,” said Dan Kern, chief investment officer at TFC Financial Management in Boston. “But it will be a huge distraction.”
The Standard & Poor’s 500 is up 19 percent this year, after the benchmark for the biggest US stocks lost 6.6 percent in 2018. But it has been drifting downward since July, with periodic up days when there seems to be progress on the trade front. The S&P 500 rose 0.6 percent Wednesday after Trump said a trade deal with China could happen “sooner than you think.”
Stocks benefited earlier in the year from the Fed’s decision to stop raising rates and from the boost to corporate earnings from the 2017 tax cut and the stock buybacks that followed. The momentum faded as businesses started feel the pain of the trade war with China. Companies are hunkering down, reluctant to invest for expansion until the trade picture clears up. Manufacturers and farmers are struggling under the burden of tariffs on Chinese imports and US exports.
Most investors remained optimistic, however, because consumers, who power nearly 70 percent of the economy, remained optimistic.
But cracks in that solid foundation of consumer confidence appeared Tuesday. The Conference Board reported that its index of consumer attitudes fell to 125.1, from 134.2 in August, a figure that was revised lower.
“The escalation in trade and tariff tensions in late August appears to have rattled consumers,” the Conference Board said in a statement.
While the confidence index remains high by historical standards — the average reading since 1985, the year it was set at 100, is 95.5 — a market shock can spook consumers enough to cause a recession. And there are plenty of potential triggers for a shock, including a military showdown with Iran or North Korea, a botched divorce between Britain and the European Union, and a complete breakdown in US-China trade.
“Macro economic risks are hard to hedge,” said Bryan Routledge, associate professor of finance at Carnegie Mellon University’s Tepper School of Business. “It’s not clear how to adjust your portfolio,” he said, so investors tend to ignore such risks until they become a reality.
What they are focusing on: the trade talks with China, though hopes are fading for a meaningful resolution before the election; the Fed, which has cut rates by a quarter-percentage point twice this year, but whose next move isn’t clear; a sharp decline in government bond yields, which can portend an economic slowdown; and an inflation rate that remains below the Fed’s 2 percent target, another sign of potential weakness.
When inflation and bond yields are low, many investors seek out stocks with solid dividends so they can generate income, according to Steve Ng, an associate professor of finance at Clark University. “We are seeing investors rotating into utility stocks,” he said. “The rotation is fairly recent and strong.”
The Utilities Select Sector SPDR fund has a yield of nearly 3 percent. Compare that to the 10-year US Treasury note at 1.74 percent, and you’ll understand why investors are taking more risk to get more income.
In fact, with interest rates low and going lower, investors have few choices but to buy stocks. It’s called the TINA syndrome — There Is No Alternative.
If that’s sounds gloomy, it is. But Kern, at TFC, isn’t forecasting a market disaster.
“The consensus is that we will get a trade cease-fire, the Fed and other central banks around the world will be dovish, and Chinese stimulus will put a floor under global demand,” he said.
“Absent a big shock, growth should remain positive, albeit tepid.”
Given all the threats the US economy is facing, from a new war in the Middle East to a bitter impeachment battle, I’ll take tepid.