Stocks Slump Into Election

11/7/2016


Stocks have dipped on rising bond yields and election uncertainty, pushing the Dow Industrials and S&P 500 Index near four-month lows. With earnings-reporting season winding down, near-term action will hinge on election results, economic news, and Federal Reserve policy. For now, our buy lists have 86% to 88% in stocks, with the remainder in a short-term bond fund.

Resurgent threats

Investors are wrestling with two resurgent threats to the stock market: Donald Trump and bond yields.

Helped by the F.B.I. director's decision to alert Congress about the discovery of new e-mails related to Hillary Clinton's use of a private server while secretary of state, Donald Trump has narrowed his deficit in recent polls.

The prediction model of The New York Times says Clinton has an 87% chance of winning the presidency, down from 93% before the fresh e-mail news. PredictWise, using betting markets, puts Clinton's chances at 85%, down from 90%.

While Trump still faces long odds, Wall Street is so alarmed at the prospect of him winning that even a small change in the probabilities has an outsized effect. Many expect stocks to tumble around the globe if Trump wins.

Fear of that sell-off makes it difficult to put recent market moves in perspective. Yields on 10-year Treasury bonds have jumped to nearly 1.8%, up from less than 1.4% in early July. Meanwhile, commodity prices and the U.S. dollar have firmed.

Normally, a rise in bond yields, commodity prices, and the dollar would signal optimism regarding U.S. economic growth, which has accelerated after a sluggish first half of the year. Growth prospects overseas have also strengthened, with recent indicators pointing to improved manufacturing output in Europe and Asia.

However, U.S. stocks have faced steady selling pressure since late September, with both cyclical and defensive stocks slumping. In part, stocks have dropped because bond yields are rising on inflation worries, not optimism regarding the economy. Based on yields of inflation-protected Treasurys, or TIPS, rising inflation expectations explain most of the increase in bond yields. Also, bond yields overseas have risen, reflecting diminished expectations for stimulus from central banks.

Conclusion

Are election worries overshadowing improvement in the economy and decent September-quarter results? Or are stocks slumping because of worries regarding stagflation, with sluggish growth and rising inflation? The answers to those questions should be clearer after Election Day. For now, we intend to watch the averages while looking for opportunities one stock at a time.


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