Geopolitical issues took center stage last week as stocks fell again and Treasury bond yields dropped to their lowest level in 2017, as tensions surrounding North Korea and with Russia over the U.S. attack in Syria had market participants worried about the impact of the Trump administration's domestic agenda.
The last few weeks have seen a change from the optimism that fueled stocks for the last five months. The reality of global complexities requiring significant attention and the quest for healthcare reform remaining elusive became clear. In addition to mounting geopolitical fears, the prospect of meaningful tax reform in 2017 appears more and more difficult.
The economy continues to perform reasonably well, but both stocks and bonds have seen significant moves over the past few quarters. The concern that fiscal stimulus will not emerge may weigh on stocks for the next few weeks. For bonds, I will be closely watching inflation signs. Given the weakness in hourly earnings, stubbornly low productivity gains and recent comments trying to talk the dollar lower, the prospect of a pick-up in inflation has waned.
I am closely watching how global affairs unfold over the next few weeks to learn more about how the administration will work with countries like China to solve world issues. If global affairs become more complicated, stocks could see a decline of 5-7%, and the 10-year Treasury could test 2%.
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