Trump vs Growth what matters more for stocks

The Trump “disappointment trade” is roaring into life after the US President failed to get his amendments to Obamacare passed by Congress. The futures market is pointing to another drop for US equities at the market open as investors’ price out some of the hype around the Trump administration’s term in office. But will this moderate decline in stocks lead to a rout?

Global growth shines as stocks sell off…

Volatility may rise and stocks may sell off at the start of this week, but they could be in for a soft landing as global growth is ticking along nicely. The Citi economic surprise index for major economies reached its highest level since 2010 on Monday, and, as you can see in the figure 1 below, this economic surprise index and the S&P 500 have been moving in the same direction for the past year. The recent divergence in the economic surprise index and the S&P 500 is an anomaly, and if history is anything to go by, these two should come back into line.

The chicken or the egg?

The question now is, will the economy follow the stock market lower, or will solid growth help stocks to recover? We think that it should be the latter. Now that Trump has failed in his quest to overturn Obamacare, he is expected to turn his sights to tax reform. He may have more success in Capitol Hill with tax policy, which matters for the corporate bottom line. So, the Trump trade may be suffering a set-back, and we could see a resumption of the stock market rally in the short-term.

At this stage we don’t think that the stock market sell-off has been deep enough to knock confidence and dent global economic growth. The recent sell-off in stocks has led to a decline in the dollar and has also led to a slight moderation in Fed rate hike expectations for the rest of this year, both of which should be supportive for stocks.

How to avoid catching a falling knife

We don’t advocate catching a falling knife, however, we don’t think that Trump’s first defeat in Congress is enough of a reason for stocks to tumble indefinitely, especially when the global economic picture is looking so bright. This is where the technical picture comes into play. 2,330 is a key level of support – the 50-day sma – below here 2,300 is a key support level to watch. If the S&P 500 holds above these levels then our argument will be justified, however, if we fall below here then we could see a deeper sell off, regardless of what global growth is doing. It is also worth watching the lead indicators such as the Dow Jones Transportation Index, if this index starts to turn higher in the next couple of days then we could see an end in sight for the S&P 500 sell off.

Figure 1:

Source: City Index and Bloomberg