Giving Candy to a Baby
Since everyone knows the US now has the “greatest economy, the likes of which the world has never seen….” what can be done for an encore? I have some good ideas.
First, let’s stimulate the economy with tax cuts. Consumer spending drives 70% of our economy and people buy more if they’re paying less taxes. Never mind the sugar high also increases national debt. Second, let’s start a trade war against the world because tariffs will make us billions! Never mind tariffs are a tax on the US consumer (which undoes the benefit of the income tax cuts); also, never mind they create uncertainty and delays in business investment. Third, if the economy softens we’ll blame the federal reserve for being slow to lower interest rates! Genius.
Wait. Those ideas are taken. And on sober reflection, if the economy is great why do we need lower taxes and interest rates? These tools are mostly used to stimulate a weak economy. Tax cuts create a spending party, but our kids and grandkids will have to pay the bill….with interest. Without the rise in national debt, economic growth would be negative according to Jeffrey Gundlach. Lowering rates, if the economy is strong, is like giving a baby more candy to keep it from crying. Is the baby trying to hide a mess? And if tariffs cause your iPhone, car price, etc. to increase by 25% spending will likely slow. Economic rationale and gamesmanship based on debt and speculation belongs in a casino.
If cheap debt is a growth panacea why isn’t it working in Japan and Europe?
One could make a case for lower rates based on several indicators (which contradict the “greatest economy” contention): freight shipments have contracted; the IHS’ PMI (manufacturing) is at its lowest level since 2009; ADP payroll reports show small business hires contracting; and small stocks have lagged large stocks for the past year. A blip? Or maybe it’s time for the policy sugar high to face reality. Market schizophrenia has been on full display – shifting from fear-to-unconcerned-to-bullish in the past 7 months.
Is the economy great or does it need help? It can’t be both.
Asset Class Review
Despite US debt that’s now larger than the US economy, markets rose in the first half of 2019, above September highs, and recouping the steep declines of December and May.
For Q2, assets rose (though Q1 was much stronger for most asset classes). Stock markets lead the way. International markets trailed the pack contending with trade tensions and a strong dollar. Of note: year over year, US and International small stocks are lagging larger companies by over 10%, this can forebode recession though it’s not a perfect indicator. REITs, whose returns are derived largely from their dividends, rose as bond yields declined.
The GSCI commodity index rose as oil went higher driven in part by news that Iranian sanctions will limit oil supply on global markets. Copper has been flat on the year. Gold spiked late in the second quarter and is up 8% for the year.
The aggregate US and global bond markets rose, as market interest rates declined. Emerging market debt lead the way higher followed closely by US junk and investment grade bonds. Treasuries lagged these other indices as investor risk appetite increased.
You can’t find the Fed, but we can fight the World?
The policy incoherence is clear: stimulate with one policy (low rates), contract with another (trade), and then point blame when things go south. Market players and politician’s want lower rates to fuel short-term growth, speculation, and consumption (and to keep their job). Contrary to popular belief, the complexities of the economy aren’t so easily prescribed.
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