Wall Street endured its worst day in months on Tuesday as it investors went into risk-off mode.


Traders seem to be reassessing the Trump trade. Will he deliver on the promise that has fuelled the gains since November? Problems with healthcare reform don't augur well for tax and deregulation efforts.

It does appear that the optimism has gone to some extent as the president seems to be mired in a Congressional swap, but we saw this happen before – in December following the Fed’s rate hike there was a softening in equities before launching another ascent, although it was not quite the +1% drop witnessed yesterday.

Has the Trump rally died? Ignoring all the noise, it might just be that the old ‘3 steps and stumble’ rule can be applied. This simply argues that the US stock market tends to suffer a substantial or even serious shock – e.g. a bear market - when the Fed raises rates three times in succession without an intervening cut.

The Fed hike in March was number 3 in this cycle. It was telegraphed in a series of lightning strikes by Fed officials in the preceding weeks, seemingly as a result of the Trump trade and rising inflation expectations. It was taken by markets initially as a dovish hike – even though the Fed is now more agreed on hiking 3 times this year rather than just 2 – but it might be that the rule is holding again. Whether you see it as a hawkish hike (3 more likely in 2017) or a dovish hike (not 4) it’s still the third hike in the cycle.

The worst phrase you can hear in the markets is ‘it will be different this time’ and it’s been heard a lot recently. Why should the three steps rule not hold this time when it has been so ably demonstrated in to hold before? There is a lot about this stock market rally that chimes with the dotcom bubble and the fact is that valuations are soaring and stocks look overpriced by a range of metrics.

Bank of America Merrill Lynch’s fund manager survey is instructive – 35% think higher rates will spark a bear market, but more importantly they think stocks are just too expensive - equities are now seen as the most overvalued in the past 17 years. Something had to give and the correction we saw in US markets on Tuesday was due. It might also be exactly what we need to help see an orderly path of normalisation by the Fed.

A fall in oil prices has not helped. It’s dropped below the 200-day moving average and is looking vulnerable as fundamental factors point to continued oversupply and total disappointment in OPEC’s production cut. OPEC looks a busted flush – if it cannot do anything in May at the next meeting crude could fall a lot further.

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