The markets logged their worst week of 2019 after gong-worthy performances from the Democratic candidates, the Federal Reserve Chairman, and President Trump. The economic data we received at week’s end exposed the undertow of trade tensions with manufacturing faltering and capital spending plans idling. As such, the economy grows more dependent each day on the strength of US consumers who now find themselves caught in trade war crossfire. August ushers in a traditionally weak performance period for markets into October, further eroding investor confidence. New highs stand only 3% above Friday’s close but reclaiming them will require better performances from our leaders or a surprising upturn in the data despite them.
The Full Story:
This last trading week in the markets was like watching a 70’s gameshow. Remember that at the end of an economic cycle, policy makers play outsized roles as economic energy dissipates. This makes markets more attentive and sensitive to policy performances. This week’s contestants include the Democratic Presidential hopefuls, the Chairman of the Federal Reserve, and the President of the United States. Ready Judges?
The Democratic Presidential Candidates
Regardless of your political leanings, markets fear profligate agendas. Unfortunately, the Democratic candidates seem dedicated to outspending one another. Making healthcare, college, immigration, guaranteed employment, and environment-scrubbing “free” sounds very expensive. The theory of cost reductions through single-purchaser government negotiations on our behalf misses a critical point. Consumers consume a lot more of whatever is free! If you could go on vacation while sending the bill piecemeal to every other American, would you vacation more? The disintermediation of consumer and payer drives prices up as demand shifts higher relative to supply. See:
Clearly, government purchasing within the healthcare and education sectors hasn’t reduced consumer price inflation – it’s almost single handedly created it! Free doesn’t reduce consumption, it increases consumption, and requires increased compensation for providers. The top 1% making over $500,000 a year cannot shoulder the financial burden of all this free stuff as the debaters reluctantly admitted. They acknowledged that the tax rates for the middle class will need to rise, then asserted that costs will fall as an offset (hmmm…see graphic above). Want to know how much money middle class Americans earn annually? $61,000. If history is correct, recharacterizing insurance premiums and education payments as tax assessments will not decrease overall inflation rates but increase them, create shortages, or lead to rationing. “Free” therefore becomes the most expensive economic option for US households. Many US systems have problems and need modernizing, but investors rightly prefer policy incrementalism rather than full-scale economic revolution.
Federal Reserve Chairman Jay Powell
On Wednesday, the US Federal Reserve lowered its benchmark interest rate by .25% as expected. Markets reacted to the official release with a yawn, having fully priced in the reduction already. Initially, Chairman Powell’s opening remarks reiterated the sound logic behind easing, “incoming information on global growth, trade policy uncertainty, and muted inflation have led the committee to gradually lower its assessments of the path of policy interest rates (needed to support growth).”
Michael McKee, Bloomberg: “Chairman Powell, how does cutting interest rates keep growth going since the cost of capital doesn’t seem to be an issue here?”
Chairman Powell: “I really think it doesn’t. I think the evidence of my eyes tells me that our policy does support, it supports confidence, it supports economic activity, household and business confidence and through channels that we understand. So it will lower borrowing costs and it will work”.
Steve Leisman, CNBC: “Would you say we have gotten into a new regime here making this an insurance cut and not a data dependent cut? And are we now in the realm of watching headlines of trade talks rather than inflation and unemployment numbers? If so, how do we know what you are going to do next?”
Chairman Powell: “So I, I gave three reasons for what we did and that is, to ensure against downside risks to the outlook from weak global growth and trade tension. So in a sense that is a risk management point, and that is a bit of insurance. But we also like weak global growth and trade tensions are having an effect on the US economy. You see it now in second quarter, you see weak investment, you see weak manufacturing. So support demand there. And also to support return of inflation at 2%. But there is definitely an insurance aspect of it. Trade is unusual. The thing is there isn’t a lot of experience in responding to global trade tensions. So it’s something that we haven’t faced before and that we’re learning by doing it. It’s not exactly the same as watching global growth where you see growth weakening, you see central banks and governments responding with fiscal policy and you see growth strengthening, you see a business cycle. With trade tensions, which do seem to be having a significant effect on financial market conditions and on the economy. They evolve in a different way and we have to follow them.”
Feeling confident, judges? If the point of the cut and press conference was to stoke confidence, then Powell never should have grabbed the microphone as his insecure, incoherent exhortations drove the Dow down 300 points which hurt investors, the US dollar surged 1% which hurt US exporters, and long term interest rates fell as a no confidence vote on economic acceleration. Gong!
President Trump mailed in his performance on Twitter with the following announcement:
Clearly, the progress on trade talks has reversed and it’s becoming a protracted cold war, but everyone seems friendly at least! To this point, the tariffs have been levied on goods that don’t directly impact the consumer. The newly tariffed $300 billion includes cell phones, laptops, toys, furniture etc. While Donald may campaign on the windfall at Treasury from all the money China pays us in taxes, the tariffs don’t hit the exporter, they hit the importer while driving prices higher for consumers. China has partially offset these price hikes by devaluing their currency roughly 5% since trade tensions escalated in April. Nonetheless, the remaining spike in import prices could frustrate an incoherent Fed reluctantly committed to a path of lowering rates. Furthermore, the consumer has once become the Atlas of our economy, with trade and manufacturing floundering. These new tariffs may target China, but they punish the US consumer. I get and admire what President Trump is trying to do by releveling our trade relationship with China, but his method often feels like madness. In agreement, the markets reacted to this tweet storm by quickly dropping over 800 points.
Bonus Segment: For those who may or may not remember The Gong Show, enjoy this retrospective from People honoring creator and host Chuck Barris. We may have been poorer in the 70’s but I think we laughed more. Enjoy!
Have a great Sunday!