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After a couple of listless weeks of trading, US equity markets suddenly felt decidedly crook overnight and coughed up some of the gains made since the party started Donald Trump's surprise election in November.
Wire copy was agog with news that the more than 1 per cent slump had been the nastiest hangover endured since the "Trump reflation trade" became a thing, and predicably the Australian and Asian market got the wobbles too.
But is it a case of severe indigestion from over imbibing and gouging on a very expensive feast, or symptoms or a more sinister malaise?
Perhaps fittingly, it appears efforts to repeal and rewrite recent healthcare reforms in the US caused the collective market dyspepsia.
Suddenly the new can-do administration hit a snag, with the more conservative end of the Republican spectrum objecting to Mr Trump's refashioning of Obamacare, highlighting the fact that not everything is going to plan.
Policy delays will weigh on markets
It also meant a whole range of Mr Trump's policy initiatives were now likely to be frustrated, delayed or derailed as a consequence.
"The market has priced in good Trump, without the bad bits," global equity strategist Gerard Minack observed.
For the market the good stuff includes tax cuts, deregulation and the ditching of bank-unfriendly Dodd-Frank laws.
Mr Minack lists the bad stuff as increased protectionism, the shrinking workforce - as 5 million undocumented workers are removed from the economy - and the unusual, if that's the word for it, operation of the Trump administration since inauguration.
"There's huge scope for disappointment for the markets, and there's been no due consideration given to the bad stuff," he said.
"The President can't rule by dictate, they (the administration) can't get stuff through when they want and now many things won't come through at all."
Risks have not been priced in
In market parlance, it is about the "fat-tailed" risk, where the current uncertain state of affairs means the difference between the upside and downside is unusually wide.
Escala Partners chief investment officer Giselle Roux said since November markets have been keen to buy the growth bull story and not factored in the potential costs of achieving it.
"It is now clear the healthcare changes will be harder to deliver, that will make the budget harder to deliver and, realistically, a lot of stuff is not going through," she said.
"Tax cuts now may be smaller and delayed."
Similarly, there are two sides to the return of an interest rate rise cycle in the US.
While there is a positive sentiment that the economy is getting stronger, the rate hikes are coming at an unusually late time in the economic cycle, with every measure of the market's valuation well above historical averages.
Corporate earnings not growing despite high valuations
Financial conditions are getting tighter and, while earnings are rising, a lot of it is low-quality growth.
Ms Roux said much of the earnings upgrades come from falling depreciation costs, which is in turn a function of low capital spending.
"You shouldn't pay a lot for that," Ms Roux noted.
Ms Roux also questioned the quality of earnings in the booming IT sector, which has yet to fully account for a flood of share options gifted to staff which will ultimately dilute earnings when they are exercised.
"Typically these sell-offs create a momentum of their own through algorithmic selling, a lot now depends on corporate earnings providing positive news to turn things around," she added.
From Mr Minack's perspective, the sell-off is somewhat overdue.
"I'm not saying there will be a crash, it's more likely to be a correction than a bear market (a 20 per cent decline)," he said.
Higher interest rates will bite harder in a mature market
Typically, tightening cycles are not great for equities, although the corrosive effect of higher borrowing costs is to a degree counter-balanced by stronger corporate earnings.
"We're starting (this cycle) from unusually stretched valuations and I'm not sure you're going to get that earnings growth," Mr Minack noted.
"Valuation is elastic, but the further it stretches the sharper it can snap back.
"I think it will be a hard second half of the year and I'm fairly cautious about US equities."
Until last night's sell off US equities were up around 7 per cent in the year to date.
Mr Minack said he's still sticking to his forecast for Wall Street to finish 2017 overall with a small retreat.
"The simple point is that higher rates hurt borrowers, hurt valuations and increase volatility," he warned.
"The only question now is how many times the Fed has to tighten to produce those effects, as it seems unlikely that the Fed will stop until at least one happens."
For Ms Roux, one of the wildcards will be a considerable upheaval in the composition of the Federal Reserve board over the next 12 months.
Two seats of the seven-member board are vacant and a third spot is expected to open up next month, while the terms of chair Janet Yellen and deputy chair Stanley Fischer expire early next year.
"We don't know whether the next board will be hawkish or dovish, and we don't know whether the Trump administration would be looking to construct a hawkish or dovish board and what it will mean for interest rates," Ms Roux said.
"I don't think it (the sell-off) is the start of something sinister, just a realisation there are greater risks than had been priced in."
In other words, the party might not be over, but it certainly appears to be winding up.
Topics: stockmarket, markets, money-and-monetary-policy, business-economics-and-finance, united-states
First posted