Market Extra: Here’s why the stock-market rally is unlikely to be derailed by Michael Flynn

0
25
views

When the bull market ends, it probably won’t be due to Michael Flynn and his agreement to cooperate with the special counsel probe into potential links between the Trump campaign and the Russian government during the 2016 elections, investors and analysts said.

“The Trump rally may be interrupted, but it will resume as long as the economy continues to improve and corporate profitability continues on the path it’s been on,” said Chris Zaccarelli, chief investment officer at the Independent Advisor Alliance.

Stocks stumbled sharply, volatility spiked, and haven assets jumped late Friday morning after Flynn pleaded guilty to charges he lied to Federal Bureau of Investigation officials in January and an ABC News report said he was prepared to testify that Trump directed him to talk to Russians. In a statement, Flynn said he planned to cooperate with the probe.

See: Former Trump national-security adviser Michael Flynn pleads guilty to lying to FBI

But the jolt was short-lived. The S&P 500 SPX, -0.20%  ended the day down 0.2%, taking back most of the drop that followed the Flynn news. At one point, the index was down as much as 1.6%. The Dow Jones Industrial Average DJIA, -0.17% which fell more than 300 points a day after powering above the 24,000 milestone for the first time, finished with a decline of just 40.76 and logged its best week of 2017.

Volatility, as measured by the CBOE Volatiity Index VIX, +1.33% or VIX, was up 1.1 points at 12.35 after jumping to 14.58, its highest since August. Haven assets, including gold GCG8, +0.50% and Treasurys, also spiked, but subsequently trimmed gains.

Lara Rhame, senior economist at FS Investments, said the immediate market reaction—a day after the S&P 500 and Dow soared to the latest in a string of records—was less a reflection on the news than it was an illustration that “the market can’t go up every day in a straight line.”

‘Buy-the-dip’ is alive and well

There have been a number of political and geopolitical developments in recent weeks, including North Korea’s latest missile launch, that could have had negative consequences but were largely ignored by financial markets, she noted.

The quick unwind of the market’s initial reaction to the Flynn news is noteworthy in that it’s “less a reflection of the severity of the news and more a reflection the buy-the-dip mentality is still dominating,” she said. “Complacency is really taking over.”

Read: Complacent investors run risk of reliving ‘parable of the boiling frog’

Indeed, there are worries about stretched stock valuations that have left equities expensive by almost any measure. Valuations, however, tend to be poor market timing signals, with stocks often remaining historically expensive for long stretches. Markets have seen muted volatility continue in 2017, while stocks have advanced at a relatively steady pace with no major pullbacks.

See: Goldman says highest valuations since 1900 leave investors in for a world of hurt

‘Buy any large selloff’

Stock-market gains have been attributed largely underlying economic strength, both domestic and global, and robust earnings growth have been major drivers of this year’s rally, which has seen a nearly 18% rise for the S&P. Market participants questioned whether the Russia probe would pose a major threat to that narrative.

Also see: Here’s why domestic unrest isn’t a worry for Wall Street

“I would buy any large selloff and I will continue to advise that course of action until I see signs of recession, because ultimately that is what will signal the end of this bull market,” said Zaccarelli.

Tax-cut hopes

Stocks appeared to regain their footing after Senate Majority Leader Mitch McConnell said Republicans have enough votes to ensure passage of their version of tax-cut legislation that had stalled a day earlier due to a procedural hurdle and deficit concerns. Investors have debated the degree to which the stock market has baked in expectations for a slash in the corporate tax rate and other measures, but note that positive legislative developments have tended to provide a boost in recent weeks.

Live blog: Republican tax bill heads for Senate vote

“I think the market’s reaction is what you get when something completely unexpected comes out of left field,” said Randy Frederick, vice president for trading and derivatives at the Schwab Center for Financial Research. “The immediate reaction is very severe and then you pull back from that.”

Also, it’s unclear at this point how damaging Flynn’s testimony could be to the president, analysts said. And even in a scenario in which President Donald Trump leaves office, Vice President Mike Pence would be fully expected to pursue tax cuts and other business-friendly elements of the Trump agenda. That could provide support, perhaps “without the distraction of a volatile leader,” Frederick said.