Record Setting Stocks Starting to Inhale Washington's Volatility

(Bloomberg) -- For better or worse, and so far today’s it’s worse, the stock market has lately come a little untethered from its foundation in earnings and economic growth and started training all its focus on politics.

Washington’s influence blew a chill through Wall Street Friday as news Michael Flynn, the former national security adviser, has pleaded guilty to lying to the FBI and agreed to cooperate with prosecutors. The news sparked an immediate plunge in equity benchmarks, lopping almost 300 points off the Dow Jones Industrial Average and pushing the Nasdaq 100 Index down 1.4 percent.

“Politics generally doesn’t have a profound impact the market but to the extent the political story results in a change in policy and affects the growth, then it does,” said Walter “Bucky” Hellwig, Birmingham, Alabama-based senior vice president at BB&T Wealth Management, who helps oversee about $17 billion. “All eyes are on the headlines right now as the market will react one way or another depending on how the story unfolds.”

It’s another twist in a volatile week for U.S. stocks, with the Dow poised for its third single-day swing of more than 1 percent, something that hadn’t happened even once since early November. Speculation about the impact of Donald Trump’s tax package had whipsawed investors until Friday when concern rose that Flynn’s testimony could hamper the president’s legislative agenda.

About an hour after the Flynn news hit, Senate Majority Leader Mitch McConnell said Republicans have the votes to pass the tax bill in the chamber. The Dow pared its loss to 150 points and the Nasdaq 100 recovered a third of its loss.

“The news coming out is still early but the market tagged onto the Trump Trade here of late,” said Gary Bradshaw, a portfolio manager at Hodges Capital Management in Dallas. “I’m going by the seat of my pants based on what I’m hearing, but we’ve had this great rally in the market, and now we have this other issue. We’ve had the rug jerked out from underneath us.”

For investors as formerly blissed out as these, it doesn’t take much to kick up turbulence, and evidence has been building for days that all was not right with psychology. The Cboe Volatility Index, Wall Street’s options-derived benchmark for anxiety, has risen for five straight days, bucking its normal pattern on Tuesday and Thursday by rising even as equities surged.

The VIX surged as much as 29 percent on Friday, the most in three months, as volume exploded in exchange-traded funds and notes used to hedge against rising volatility. By noon today, the iPATH S&P 500 VIX Short-Term Futures ETN had notched volume of 55 million shares, roughly equal to its full-day average in 2017.

Speaking in court as part of his plea agreement, Flynn, 58, said Trump asked him to make contact with Russians and that he told incoming administration what he was doing. Flynn called a senior official from the transition team for guidance before talking to the Russia’s ambassador to the U.S., and then reported back to the transition team after the call.

“I don’t know if it’s shocking, at least not since Flynn cut off communications a couple weeks ago,” Jim Paulsen, chief investment strategist at Leuthold Group LLC, said by phone. “But as far as the markets, markets don’t like volatility of any kind and this creates the possibility of uncertainty in the White House.”

To contact the reporters on this story: Sarah Ponczek in New York at sponczek2@bloomberg.net, Elena Popina in New York at epopina@bloomberg.net.

To contact the editors responsible for this story: Jeremy Herron at jherron8@bloomberg.net, Chris Nagi

©2017 Bloomberg L.P.