For the past several months, the stock market has faced pressure because of worsening relations between the U.S. and its major trading partners. However, a bigger risk could be the tense relationship between the two major U.S. political parties.
According to a new survey from Wells Fargo and Gallup, the “political climate in Washington” is seen is the biggest threat facing the U.S. market, with nearly half of those polled saying they were “very worried” about this issue. Another 30% said they were “somewhat worried,” with fewer than a quarter of respondents saying they were either not too worried, or not worried at all.
“Most people would say the political climate has become highly partisan, and that’s certainly come into account here. Not only are those on the left highly unhappy, but this is an unconventional administration, and that causes some uneasiness in investors, even those on the right,” said Erik Davidson, chief investment officer at Wells Fargo Private Bank.
“There’s so much partisanship that it impacts everything from trade to the Supreme Court to the upcoming midterms. What’s disruptive for investors is the lack of certainty. Even though good things are happening, such as lower taxes, there’s an unpredictability about what’s happening. That’s partially about how this administration works, but it also feels like this is such a partisan environment that nothing can get done.”
Davidson added that the number of investors citing the political environment was “particularly high,” and that while the Obama years also featured high levels of partisanship, he didn’t believe that the current survey had ever been eclipsed, in terms of the percentage of respondents citing that as a risk.
While trade issues have been the primary driver of day-to-day market activity of late, resulting in both investor optimism falling and investors trimming their exposure to stocks, “trade relations with China” was only the fourth-most-commonly cited issue, based on the ratio of respondents who said they were very worried about the issue. However, while this factor was broken out as a separate issue, Davidson noted that “the overlap is significant” between the respondents who cited trade issues, and the ones who cited the political climate more broadly.
“We wouldn’t be having this trade issue unfold this way if not for the political environment,” he said.
While 43% said they were somewhat worried about the trade issue, only 28% said they were very worried, a level that put it behind both the size of the Federal budget deficit (35%) and cyberattacks on either businesses or government (32%).
The results of the survey are below.
Despite these issues, the Wells Fargo/Gallup Investor and Retirement Optimism Index nevertheless suggested investors generally were sanguine about the outlook for equities. The Retirement Optimism Index came in at 103 in the second quarter, and while this is down from a recent reading of 117, it marks the sixth straight quarter above 100. According to the firm, the index was consistently below triple-digits over the past 16 years.
Thus far this year, the Dow Jones Industrial Average DJIA, +0.41% is down 1.1% while the S&P 500 SPX, +0.85% is up 3.2%. The Nasdaq Composite Index COMP, +1.34% has gained 11.4%, thanks in large part to the outperformance of large-capitalization technology and internet stocks. While uncertainty surrounding trade has kept markets trading in a tight range, they have also received support from a strong labor market and stellar corporate earnings.
“While investors are enjoying current market conditions and the strength of the economy, they appear to be sleeping with one eye open,” Davidson said. “They are optimistic, but they also have clear concerns about what factors could impact markets and drive volatility.”
Read: Investors look to the second half of 2018 expecting growth—amid rising uncertainties
Political issues will likely remain in focus over the coming months. Market volatility is expected to remain elevated as the midterm elections approach in November. In April, Goldman Sachs referred to the coming election—where either the Senate and the House of Representatives, or both, could flip to Democratic control—as “yet another source of policy risk and volatility.”
Another political risk could come from the investigation currently being conducted by special counsel Robert Mueller into Russia’s interference in the 2016 election and other issues arising from that. While developments related to the investigation—such as Trump’s former national-security adviser Michael Flynn pleading guilty to lying to the Federal Bureau of Investigation—have resulted in equity volatility, these proved short lived. Should it expand, however, that could introduce a major element of political risk into the market.
Last year, Joshua Brown, CEO of Ritholtz Wealth Management and a closely watched market commentator, said the Mueller investigation represented a potential “major shock” that could hurt stocks this year.
Read: Why political risk may return to stocks in a big way in 2018
