Has the stock market reached the high-water mark for the Trump era?
Last week the S&P 500 stock index fell 5.9%. The week's losses wiped out the year-to-date gains in the market. Stocks started 2018 on a tear, following the enactment in December of the Trump tax cuts. There was a sharp rise in the market in January. This was followed by a blip in February brought on by concerns that inflation and interest rates might be rising too quickly. Strong employment data quickly restored confidence that the economy was on the right path, and stock prices resumed their rise.
Until last week.
As the tag-line for a disaster recovery firm says, it's like tax cuts "never even happened".
Pundits like to have an explanation for everything, and this week there are explanations everywhere.
Here are a few candidates: High level personnel changes in the White House, the latest rumors and activities in the never-ending but going nowhere Mueller probe of alleged Russian-Trump collusion, a new chairman at the Fed, a quarter point rise in short term interest rates, announcements by the Trump administration of new tariffs on goods from China, announcements by China of new tariffs on goods from the USA, and finally, the passage and signing of a massive new deficit spending bill.
Depending on your own confirmation biases, any one of these could be the explanation you are seeking for the market's behavior.
For me, The Explanation is the passage and signing of the deficit spending budget bill. Milton Friedman, the great 20th century economist, said:
It is my view that what is important is cutting government spending, however spending is financed. A so-called deficit is a disguised and hidden form of taxation. The real burden on the public is what government spends...
I heartily agree with this. And, if my hunch is correct, many market participants agree with this analysis too. I believe they saw the passage and signing of the spending bill last Friday as the reversal of the Trump tax cuts of last December. Even worse, they realized that the Republicans threw away whatever remained of their reputation as the fiscally sound party. Sure, President Trump tried to deflect blame for the spending excesses on the Democrats, who were celebrating their "wins". But it was the Republicans who passed the bill, and the President who signed it. They own it, and they will have to defend it at the midterms. I think that is the reason the stock market fell 5.9% last week. And why I think the worst is not over.
What is objectionable in the deficit spending budget just enacted? Simply put, spending that is out of control. There is no mechanism to reign in government spending. Who is willing to stand up and say that trillion dollar deficits in the ninth year of an expansion is simply economic lunacy? There is no economic discipline in Congress, and the hoped for stable-cleaning by President Trump did not happen.
Perhaps I am wrong. Perhaps the markets were spooked not by trillion dollar deficits, but instead they reacted to President Trump's tariffs and a possible trade war. This would be a serious problem if it were allowed to get out of hand. But if President Trump really wants to reduce trade deficits, he needs to reduce budget deficits. It is a little known and even less understood fact that budget deficits and trade deficits are tightly linked. When the government borrows a trillion dollars, where does the money come from? From savers of course. But the US savings rate is not high enough to finance the government deficit and to finance new economic investments. Something has to give. Investment in business development gets "crowded out", in economic jargon. Deficits starve companies of investor's savings, and put their plans for expansions on the back burner.
Unless, that is, unless foreign savers are willing to make up the shortfall. Which they have been willing to do, especially since the Bank of Japan and the European Central Bank have been even more forceful than the Fed in suppressing interest rates. The US is the best house in a bad neighborhood when it comes to buying government bonds. Foreigners (who sold us imports we paid for with US dollars) have dollars to spend. But they are not buying US-made goods or services; instead, they are buying US government bonds to finance the debt or US companies securities to finance business development. Hence a large budget deficit "crowds out" US export goods and services. The result is a large trade deficit.
One way to reduce the trade deficit is to reduce the budget deficit. But the spending bill President Trump just signed will work to increase the trade deficit, just the opposite of his stated objectives.
But perhaps both of these explanations are wrong. Perhaps the real culprit in last week's market swoon was the Fed action to raise interest rates, with a promise to raise rates another quarter point three more times this year. Certainly, that would change the valuation algorithms, and reduce prices. But the move was well signaled by the Fed, so there was no surprise in the Fed statements, or in any of the remarks by new Fed Chairman Jerome Powell. It is still a good candidate for The Explanation as to what caused prices to fall. If this is the real explanation for the market reaction last week, then we should see markets get back on their feet quickly, since the new level of interest rates is now factored into price valuations. We can only hope this is The Explanation. I suspect not.
So what, you might be asking? What should we be doing? Well, about your 401(k), or your savings, now might be a good time to be more conservative with your investments. Sell any shares in companies that you don't want to be owning for a long time. Raise cash for possible opportunities down the road. Evaluate your personal budget. Are you living within your means? Make changes to your personal spending to prepare for the future. Adjust your giving to give even more. It's a great way to celebrate your blessings. And despite the chaos around us, we are blessed.