The turmoil engulfing the White House rattled the world's financial markets on Wednesday, leaving investors to question whether markets can remain resilient to U.S. political turbulence.
A textbook risk-off trading session on Wednesday saw stock benchmarks around the world suffer through their worst day in eight months, while government bonds and gold prices rose, as investors fled to safety. The selloff ended a long streak of tranquility in global equities that stood in contrast to the discord emanating from Washington.
"One has to wonder if Mr. Market is either in denial or merely clueless as to what is going on and how this is going to affect the so-called pro-growth agenda going forward," David Rosenberg, chief economist at Gluskin Sheff + Associates, wrote in a note to clients.
Explainer: Who is Robert Mueller, and what will he do? A primer on the Trump-Russia probe's new player
On Wednesday, the market tuned in. Major stock indexes in Canada, the United States and Europe fell by between 1.6 per cent and 1.8 per cent, making for the worst trading session since September, 2016.
The cascade of scandal surrounding U.S. President Donald Trump has the potential to hold the market's attention well beyond a single trading day, Peter Cardillo, chief market economist at First Standard Financial, said in a note on Wednesday. "We think the situation is likely to change as this crisis leads to an interruption of the pro-growth White House agenda, deflating the Hope Rally," Mr. Cardillo wrote.
Otherwise known as the Trump Rally, the Hope Rally is a banner that's been applied to the rise in stock prices since Mr. Trump was elected last November.
The surprise result on election day added momentum to U.S. stocks in general, and those sectors of the stock market that might benefit from inflation in particular.
Mr. Trump's pro-growth platform, including huge cuts to corporate and household taxes, a vast infrastructure program, financial deregulation and the repatriation of foreign cash, sent investors clambering for stocks with the most cyclical and reflation exposure.
Even before the election, the reflation trade was under way. In the nine months prior to election day, the market's biggest winners included pro-cyclicals such as industrials, technology and financials. Among the laggards were defensive and rate-sensitive sectors such as real estate, utilities, consumer staples and telecom. All of which is indicative of economic optimism, which was largely supported by improving readings on the U.S. economy.
The election supercharged the reflation trade, as U.S. benchmarks rocketed to new record highs on the strength of financials and tech stocks. From early November to early March, the S&P 500 rose by 15 per cent. Canadian stocks went along for the ride, with the S&P/TSX composite index rising nearly 10 per cent over roughly the same period.
But in early March, the Trump Trade started to reverse. Inflation forecasts began to soften. And bank stocks, which were to be beneficiaries of the Trump administration both through an economic resurgence and the easing of industry regulations, sold off sharply.
What has largely prevented U.S. stocks in general from declining over that time has been the tech sector.
"The major averages are really being skewed by a handful of large-cap, blue-chip growth stocks," Mr. Rosenberg said.
Before Wednesday, the so-called FANG stocks – Facebook Inc., Amazon.com Inc., Netflix Inc. and Google parent Alphabet Inc. – were all up by 20 per cent to 30 per cent year to date.
But in a one-day rebuke of the Trump Trade, technology and financials were the two worst sector performers of the day on Wednesday.
Apple Inc. fell the most in six months amid investor concerns about the likelihood of Mr. Trump's tax reforms being passed. Apple has $240-billion (U.S.) in cash and equivalents outside the United States and Mr. Trump has proposed a tax cut to repatriate offshore holdings. "The progress of legislation, particularly taxation reform, may not be as smooth as people expect," said Colin Gillis, a New York-based BGC Partners analyst with a hold rating on Apple stock. "Apple has the most to gain on foreign cash repatriation."
Big banks were among the biggest of Wednesday's losers, with shares in Bank of America dropping by 6 per cent, and JPMorgan Chase and Citigroup each losing 4 per cent. But arguably the greatest threat to investors over the short term is the risk of sentiment materially deteriorating.
"Confidence can be fleeting," Citigroup's chief U.S. equity strategist Tobias Levkovich said in a note. "[But] we suspect it is too early to consider a downturn in that optimism since a week or two of bad news does not derail a view."
With a report from Bloomberg
Want to interact with other informed Canadians and Globe journalists? Join our exclusive Globe and Mail subscribers Facebook group