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US equities could tumble 10 percent if legislation disappoints, says Blackstone’s Studzinski

U.S. equity markets could tumble by up to 10 percent if investor hopes for corporation-friendly reform fail to translate into legislation, according to Blackstone Group Vice Chairman John Studzinski.

The veteran financier, who joined Blackstone in 2006, advised watching President Donald Trump's progress in getting approval for his key platform initiatives from U.S. Senators between now and the summer recess during which Congress closes for the month of August.

"We'll have a better indication by the August recess whether he's going to actually accomplish something or not," Studzinski told CNBC's Squawk Box on Monday.

"If by the middle of August nothing happens - and I doubt it will - then you'll see the stock market react with even greater caution than it has now," he added.

As the debate continues to rage over whether valuations for U.S. equities have overshot, Studzinski says it is important to watch the level of investor uncertainty around legislative changes given the potential for a "major re-rating" of shares should it develop.

On that note, the senior Blackstone executive pointed out in a conversation with CNBC on Friday that it is important to remember that volatility has gone up and should be closely watched. On the other hand, interest rates are not what investors are focused on, despite a growing consensus that a couple more rate hikes will be implemented before year end.

Indeed, looking at the impact of legislative matters on market behaviour, equities reacted poorly to the recent failure of Trump's team to secure sufficient support in the House and Senate to repeal 'Obamacare' (the healthcare program pushed through under former President Barack Obama) and the consequent forced withdrawal by Republicans of their healthcare bill.

However, a relief rally of sorts trickled through the following day, with some market participants and media sources attributing the uptick in stocks to a perception that the Trump team's willingness to shelve the healthcare bill for now demonstrated its appetite for focusing on tax reform – an issue to which financial markets are notably more sensitive.

Traders work on the floor of the New York Stock Exchange (NYSE).
Michael Nagle | Bloomberg | Getty Images
Traders work on the floor of the New York Stock Exchange (NYSE).

However, Jim O'Sullivan, chief U.S. economist at High Frequency Economics, says he anticipates the tax legislation that passes will be much less transformative than the current House plan.

"We expect negotiations will eventually result in some lowering of marginal tax rates, however, along with some offsetting base-broadening measures to prevent the deficit from rising significantly," O'Sullivan wrote in a note to clients on Monday.

Meantime, it is instructive to look at the different reactions of U.S. bond and equity markets, Neil Dwane, chief investment officer equity Europe at Allianz Global Investors, told CNBC on Friday.

"The bond markets clearly don't buy the whole stimulus otherwise we probably would be at 3 percent on the 10-year Treasury…the fact that everyone has already placed negative bets and the 10-year hasn't gone down in the last couple of months would suggest there are a lot of other people in the bond markets who think growth is slipping through the economy's fingers and it will be lower and slower," Dwane explained.

"Whereas the U.S. equity markets, certainly some of the more cyclical sectors, have gone through the roof without a single order having been issued yet," he added.

Ultimately, Dwane agrees, the key factor for markets to watch is whether Trump will be able to get his measures through or whether he stuck in the metaphorical swamp of a deeply divided batch of lawmakers in Washington D.C. who block his initiatives.

"So far the swamp is doing a good job," observed Dwane.

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