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For the first time since the election, Trump optimism is showing signs of cracking

For the first time since the election, markets are doubting they will get the pro-growth policies of tax reform and stimulus promised by President Donald Trump and the Republican Congress.

The repeal of Obamacare appears to have hit some snags and the GOP brought out Trump earlier Tuesday to serve as pitchman to House Republicans who may have been wavering ahead of Thursday's vote. Whether he won votes or not is unclear, but markets certainly took the lack of clear majority support as a negative.

"I think it's certainly interesting the market is questioning it, based on the limited amount of votes the Republicans can afford to lose in the House. It suggests if you thought this party would be voting as a block on the key agenda items, that might not be the case," said Mark Cabana, head of U.S. short rate strategy at Bank of America Merrill Lynch. "It might be a lot more fractured party than many might have anticipated."

The stock market sold off sharply with many market leaders of the Trump trade lagging. The Dow was down as much as 200 points, but the underpinnings of the market were even weaker. The Russell 2000 small-cap index, for instance, fell 2 percent, and the Dow transports lost 1.7 percent. Financial stocks were the worst performers, down 2.6 percent.

As investors sold stocks, they snapped up bonds. As a result, Treasury yields, which move inversely to price, moved lower. The 10-year Treasury note was yielding 2.43 percent in afternoon trading, falling from a high of 2.49 percent earlier.

"That's in the context of a market that was priced for the ultimate outcome," said Peter Boockvar, chief market analyst at The Lindsey Group. The Dow is up 13 percent since Election Day. Boockvar said the market has been ignoring how the stimulus and tax reform promised by Trump would be paid for. "Now people are beginning to realize there's potentially other issues."

The possibility of health-care reform becoming a quagmire has been a concern for markets for weeks, but there had not been a clear move in response to that concern since stocks started going higher right after the election. Trump administration officials have promised that after the health-care act that tax reform would be up next on the agenda, and there was hope there would be movement on it by August.

House Speaker Paul Ryan said Trump "knocked the ball out of the park" when he spoke to House Republicans Tuesday morning. Ryan also pushed back against the claim by the House's conservative Freedom Caucus that the American Health Care Act does not have enough votes to pass the chamber. That group later threatened formal opposition of the bill, unless there are significant changes.

"From a policy point of view, this is the first real test of Ryan, McConnell, Trump. Is it a juggernaut or isn't it a juggernaut? The markets are more interested in a substantial point of view on what's going to happen on taxes, and what's going to happen on regulatory reform," said Tom Block, Washington policy strategist at Strategas. Even if the bill does pass the House, it faces opposition in the Senate, where Sen. Mitch McConnell is the majority leader.

The unfraying comes at a bad time for Trump. On Monday, FBI Director James Comey said the bureau is investigating Russian interference with the presidential election, including any links to Trump. He also said there was no proof of Trump's assertion that President Barack Obama had ordered a wiretap of Trump Tower.

The market ignored the slam at Trump's credibility, and while the president himself may be Teflon, the market is not when it comes to his policy initiatives.

Cabana said he expects the Republicans to pick themselves up quickly if they fail on health care, and press forward with something they can win on. "In the not-too-distant futures, Republicans are going to need to pivot," he said. Cabana said they may find more agreement on tax reform, though there is clear disagreement on the border adjustment tax, which is now part of the House plan.

The House GOP proposes a 20 percent tax on all imports coming into the U.S. but no tax on exports. That would help generate $1 trillion in revenue over 10 years, and allow the Republicans to drop the corporate tax rate to 20 percent. But there is disagreement over that tax, and it has opposition in the Senate.

Rep. Kevin Brady, R-Texas appeared Tuesday on CNBC's "Squawk Box" and said the border adjustment tax was a "given." The SPDR S&P Retail ETF was down 2 percent Tuesday. The tax is opposed by retailers who say it is a penalty on consumers who would pay more for goods. However, the tax is expected to push the dollar higher and that could eliminate the inflation caused by higher prices. Proponents of the tax include industrial companies like General Electric and Boeing.

But the health-care plan stands in front of that.

"I certainly do think if this doesn't go through, it increases the risk of a risk-off move and you could see a temporary movement into bonds," said Cabana. "We still remain overall optimistic something will get done, and that underlies our view for higher overall rates. The Fed is going to continue to move gradually. We do believe rates will move higher. This certainly does increase near-term downside risk."

Earlier Tuesday, Bank of America Merrill Lynch released its monthly fund managers survey, with a record number saying the market is extremely overvalued, and just 10 percent expecting to see U.S. tax reform passed by Congress before its August recess, as promised by the administration.

"Investor positioning argues for a risk rally pause in March/April, with allocation to equities at a two-year high and bond allocation at a three-year low," said Michael Hartnett, BofAML's chief investment strategist said in a note. "Policy is the key catalyst for the Icarus trade to fly higher in the coming months."

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