Last Week: Major Forces Conflict

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Last week provided a vivid example of the powerful forces currently influencing stock prices.  On Monday and Tuesday, prices rose, reaching all-time highs on some market indexes.  Despite underlying fundamental conditions that have historically corresponded with far lower valuation levels, short-term traders continued to buy even the smallest price dips.  After more than eight years of financial stimulus from the Fed and other major world central banks, fear of market declines has virtually disappeared.

Then came news that ex-FBI Chief James Comey had taken contemporaneous notes of his conversations with President Trump that included a request from the President that Comey not continue the investigations of former National Security Advisor Michael Flynn.  Stock prices gapped down by about 125 Dow points on Wednesday morning, reflecting fear that stepped-up investigations of alleged administration collusion with Russia could derail or at least seriously delay highly anticipated business-friendly Trump administration tax, deregulation and foreign money repatriation proposals.  The buy-the-dippers largely stepped aside for the full day, and fear prevailed with the Dow closing at its low for the day, down 372 points.  Volume increased substantially.

Selling pressure pushed Dow prices down another 50 points in Thursday’s early trade, but algorithms elevated prices off that low.  One can only estimate the collective attitude of traders, but it would be logical to expect that sellers would stand aside to see if the early rally “had legs”.  When no significant selling materialized after the morning rally, another “algo-like” advance took prices up again in mid-afternoon (New York time).  Some selling came in in the last hour and a half, but the market closed up on the day.

No follow-through to Wednesday’s massive decline and some friendly comments by Fed Governor Jim Bullard gave traders the courage to make another run for the highs on Friday morning.  The rally gained strength through the day until stories hit the newswires that 1) the President had told the Russian Foreign Minister and Ambassador in the White House that his firing of Comey had greatly eased pressure on him relative to the Russian investigation and 2) that an unnamed current senior member of the White House staff was a “person of interest” in the Russian collusion investigation.  That news release cost the Dow about 75 quick points.  Nonetheless, the market retained most of its strong gain for the day and closed the week down about 100 Dow points, less than one-half of one percent.  That’s a relatively small decline given some significant volatility.

The week’s activity showed us a few things.  Traders are still eager to push prices higher, and they retain a high degree of confidence that central bankers will continue to step in if danger of a significant market decline presents itself.  At the same time, however, the market shows its nervousness about political news that could distract from the proposed legislative agenda or, worse, tie the country up in a vitriolic impeachment fight.

With valuations and debt levels in extremely dangerous territory, it is essential that investors retain their confidence if prices are to remain near record levels or to advance further.  For investors with largely irreplaceable capital, the potential for negative surprises should dampen willingness to expose large portions of that capital to overvalued equities.