Daily Comment (August 18, 2017)

by Bill O’Grady and Thomas Wash

[Posted: 9:30 AM EDT] Yesterday saw a selloff in U.S. equities.  We are not seeing much of a recovery this morning.  Here is what we are watching today:

Barcelona: Using rented vans, a group of terrorists who claimed allegiance to ISIS tore through a tourist area of Barcelona, killing 14 (so far) and injuring over 100.  One of the disturbing parts of this event is how far the drivers of the vehicle moved before stopping.[1] There was a second attempted attack in Cambrils, a city about 70 miles south of Barcelona.  Police were able to thwart the second attack.  A number of people have been arrested.  Three vans were rented, so police are searching to find all the vehicles.  Although this attack was horrific, there are signs it could have been much worse.  The previous night, there was a gas explosion in Alcanar, a town south of Barcelona, that may have been a bomb-building facility for the terrorists.  We note that the terrorists in Cambrils were wearing fake suicide vests; it is possible the group intended to use explosives in their van attacks and were left with using the vehicles as weapons when the bomb-making apparatus failed.  Recent terrorist attacks in Europe are increasingly using vehicles as their weapon of choice.  Guns can be traced and explosives, though effective, require some degree of expertise to build.  But, most adults can drive cars.  Thus, one of the most ubiquitous elements of modern life has become a threat.  Market effects from terrorism tend to be short-lived; we are seeing some weakness in Eurozone equities but that is probably more due to yesterday’s U.S. selloff.

The “Cohn correction?”  We think this is the first time in our memory that financial markets are concerned about whether or not a presidential advisor is staying.  To a great extent, this is more about what Cohn represents.  As we noted yesterday, the Trump administration has included both economic nationalists, who want a populist agenda, and globalists, who represent the GOP establishment and favor globalization and deregulation.  The financial markets appear to have assumed that, in the end, the globalists would win out, bringing tax cuts, deregulation and continued open trade.  In reality, the evidence is mixed.  The president has made some steps toward impeding trade, although the moves have been more modest than the rhetoric.  At the same time, there has been lots of talk about tax cuts, although there is no detailed plan for legislation.  After the Monday press conference, speculation grew that Cohn might resign.  Recent reports suggest he intends to stay.  However, if he does leave, it might signal a broader exit of establishment figures in the administration and raise the odds that the nationalist agenda will dominate.  This outcome is clearly not well liked by the financial markets.  If the White House adopts a nationalist economic policy, it would create conditions of higher inflation.  Of course, the White House can only do so much; the president can clearly affect trade with significant independence from Congress.  On the other hand, tax policy and spending priorities need congressional approval.

Still, as we note below, there is no economic evidence of a recession which means that pullbacks will likely be short-lived.  In addition, as we noted in last week’s Asset Allocation Weekly, there is ample liquidity in the economy which should support the equity market.

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[1] https://www.nytimes.com/interactive/2017/08/17/world/europe/barcelona-terror-attack-path-of-the-van.html?emc=edit_mbe_20170818&nl=morning-briefing-europe&nlid=5677267&te=1