What Congress gets done and how CEOs act will matter plenty. But to monitor the fortunes of the stock market and economy under President Trump it's best to focus more closely on the all-seeing, no-nonsense bond market than anything else.
Bill Clinton memorably, and profanely, lamented shortly before his first inauguration that his economic agenda and re-election chances depended on "a bunch of [expletive] bond traders."
It was largely so, then and now. Yet while Clinton needed the bond market to bless a fiscally-restrained budget and keep interest rates from flying too high, the market and the president now should desire something different: For Treasury yields to resume their rise - though not too far or too fast - as validation of higher growth and inflation prospects. And, crucially, Trump and stock-market bulls require investors to keep buying up corporate bonds and holding risk spreads drum-tight.
The "Trump Rally" essentially lasted just five weeks after the election. Markets have been idling since. The week of Dec. 12, the 10-year Treasury yield hit a high of 2.62 percent, and that's when the S&P 500 stalled. It closed at 2271 on Dec. 13, and that's exactly where if finished Friday, as the 10-year sat at 2.47 percent. Over the 13 trading sessions in 2017, the S&P managed a gain on only one day when the 10-year yield fell.
These cross-market dance steps can go in and out of style. But for now it seems the bull case rests on "reflation" – a strong patch of the economic cycle, global manufacturing indicators climbing, commodity prices on the rise, and some U.S. policy stimulus as a kicker to these trends.
Bank stocks - a leadership group and favorite of the fast-money crowd – have pulled back with yields after arguably running too far ahead of the rate move. And the cyclical sectors require the pricing power that comes with better nominal growth to justify the rallies they've had.
Citigroup strategist Tobias Levkovich argues that equities can do fine if bond yields climb from here. He points out, "the stock market did not get that much of a valuation benefit when bond yields were so low" beginning in 2011, when investors priced Treasuries for an outlook of unending slow growth and nagging risk of deflation. So if the 10-year gets up around 3 percent, it shouldn't in itself prevent stocks from holding their valuations and perhaps gaining on the benefit of the expected pickup in earnings this year.
Conversely, if Treasury yields retrace much more of their recent rise, we could be back in that early-2016 situation - relying on the expensive, defensive, dividend stocks to hold the market together.
The idea that higher yields can represent good things for stocks depends heavily on whether the corporate-debt market remains as robust as it's been. Spreads on the investment-grade corporate bond index are below 1.3 percentage points – levels last seen in May 2015. That was the prior equity-valuation peak, and when spreads then started rising, stocks were thwarted for months until the punishing 2015-'16 correction kicked in.