Remember the days of risk on/risk off? Well, welcome to the world of Trump on/Trump off.

The market, remember, had been in the throes of a two-week losing streak, one that had a lot to do with what President Donald Trump said. Last week, that streak came to an end because of what his administration might do. On Tuesday, reports of progress on tax reform helped push the Standard & Poor’s 500 index up 1%, and while the major benchmarks stalled after the president called for a government shutdown if money wasn’t allocated for a border wall, it rose 0.2% on Friday as tax reform became the focus once again. “That helped underpin the market,” says Quincy Krosby, chief market strategist at Prudential Financial.

And underpinned it was. The S&P 500 finished the week up 0.7% at 2443.05, while the Dow Jones Industrial Average rose 139.16 points, or 0.6%, to 21,813.67. The Nasdaq Composite gained 0.8% to 6265.64.

Don’t be surprised if the market bounces back and forth as the focus shifts between pro-growth policies such as tax reform and deregulation, and fears of a debt-ceiling standoff or a government shutdown. Keith Lerner, chief market strategist at SunTrust Advisory Services, observes that while a shutdown has an economic impact, it’s more like a winter storm, and the effect is generally short-lived. There have been 18 shutdowns since 1976, he says, with the S&P 500 dropping 0.6%, on average, when the government is closed. The largest decline—a 4.4% drop—came in 1979 when President Jimmy Carter vetoed a bill that included funding for a nuclear-powered aircraft carrier. The takeaway: “Political showdowns tend to be short-lived and generate little permanent effect on the stock market,” he says.

Still, a standoff over the debt ceiling or budget would come at an inopportune time. Despite the S&P 500’s rally last week, the percentage of stocks trading above their 200-day moving average dipped below 50% early last week, a sign that “fewer stocks are supporting the overall index,” says Thomas Lee, head of research at Fundstrat Global Advisors. That’s happened 24 times since 1996, Lee says, and in 23 of those cases the S&P 500 fell to just below its own 200-day moving average. That suggests the S&P 500 could drop to 2300, Lee says, down around 6% from Friday’s close. If something goes wrong with tax reform or other policy issues, it could be just the catalyst the market needs for a selloff. “It’s unpredictable,” Lee says. “We don’t know how the market will react to anything.”

Federal Reserve Chair Janet Yellen’s speech at Jackson Hole, Wyo., was supposed to be the event of last week, but instead was overshadowed by tax-reform talk. But make no mistake: The Fed is still looking to shrink its balance sheet, and even hike interest rates again this year. This Friday’s U.S. payrolls report could go a long way toward determining whether the Fed will sit on its hands—as the futures market is currently predicting—or keep on tightening. “It could certainly push up the odds for a hike in December,” Prudential’s Krosby says.

And that, of course, would bring risks of its own.

(Source: Barrons Online)