That is the big question. The quick answer is that it will not be easy. Spending has gone through the roof since the end of the fiscal year last October. We have already racked up an $840 billion deficit versus $532 billion the previous year. As the chart shows below, the first four months (dark blue line) exceed all the years of recent spending by the Biden Administration. This is an ominous trend.
It is important to remember that all these alarming trends were in force well before Trump took office.
Expect the Democrats to blame Trump for all negative consequences even though it was their policies that got us to the edge of the cliff.
President Trump has been handed an awful fiscal situation for our government.
Despite what others say, we also think he was handed a weak economy. Too much of our recent “growth” has been the expansion of government employees and spending on healthcare. Almost half of the GDP growth came from those two sectors.
The stock market has been priced to perfection. It is valued in the 95th percentile, which, in plain English, means it has been more expensive than today only 5% of the time.
The market is elevated partly because of the expectation of continuing government spending and lower interest rates. We know a substantial amount of the expenditure will be cut, and the government will not hire but instead let people go. When so much economic “growth” is government, cutting back government will cut back growth in the short term. The markets seem to sense this finally and are recalibrating.
Meanwhile, the trade deficit is ballooning as businesses front-load imported inventory in expectation of tariffs, which can influence GDP numbers. Trade deficit numbers subtract from GDP, while building inventories add to GDP. While the two numbers eventually align, they can be out of kilter with each other in the shorter term. This could cause the reported GDP to fall and explain why the Atlanta Fed estimates have changed erratically. Moreover, the massive swing towards trade deficits is starting to weaken the dollar.
In addition to this volatile mixture, we must add the proposed tax cuts on Social Security and tips and the economic effects of upending the current trade regime with tariffs. We need additional revenue and reduced spending to close the budget gap.
And if Congress does not act, we could have a massive tax increase as the economy is fading.
The hope is that the adverse effects of reduced government spending can be offset by the stimulus of the private sector, lower taxes, reduced regulation, and the growth of domestic industry due to more equitable tariff policies.
The Federal Reserve pivoted and cut interest rates, saying inflation was tamed. However, interest rates went in the opposite direction, and inflation is showing no signs of being tamed and appears to be re-accelerating. That makes stimulus through lower interest rates problematic.
No wonder the stock market has given up all of its gains since the election and is increasingly volatile. It is damn hard to figure out what all these colliding forces will produce. Such confusion is difficult to digest in the best of times, let alone for a market in the 95th percentile of valuation.
To quickly update market conditions from our last entry, we did fall to and below 5800 and are now making contact with the 200-day moving average. This is approximately 7.5% down from the all-time peak and back to the level the market was at seven months ago. Such a retracement is normal, but whether the market can bounce here or breaks below resistance is an event coming up just ahead and deserves your attention. Most of our momentum indicators are now flashing “oversold”, and the CNN Fear and Greed Index, which we suggested would fall below 20, has indeed dropped to a reading of 17, or Extreme Fear. This argues for a bounce soon in the market, but a retest of those lows is likely after the bounce. If that is successful, it will be positive. A failure would be negative. It appears the caution we have expressed multiple times in this column since the election has proven well-founded.
So far, the weakness has been concentrated in the Magnificent Seven, who have been instrumental in driving the market higher. Below is an ETF of the MAGS; you can see it is down almost 19%, close to three times that of the mainstream market. It, too, is now at the 200-day moving average, and it, too, is oversold.
Also of interest is that foreign stocks have been performing better than US stocks. International stocks are up about 7.5%, opposite a similar decline in the S&P. That is quite a change. US stocks have been beating international stocks for 16 years, but something has started to shift.
That last observation, that foreign markets are rising faster than the US market, also challenges a popular current narrative: The financial press constantly tells us that US markets are selling off supposedly because of a potential “trade war.” Actual trade wars affect all trading partners. How come European markets are doing better? Wouldn’t they be hurt by a trade war, too? If true, then why are they outperforming?
Moreover, why would the US request for reciprocal treatment (foreigners charge the same tariff rate we do) be considered “a war”? There are only two ways to get reciprocity. Either we increase tariffs to match what others charge us, or they lower their tariffs to be the same as ours. Why is reducing tariffs by our trading partners never considered a possibility. Why does the financial press not call for that solution? If we ask for equal treatment, that request is considered “war.” Under those criteria, the only way to achieve “peace” is never to respond to an attack.
And in deference to the Wall Street Journal Editorial page, why don’t foreigners lower their tariffs to the level we charge? Is that not free trade? Doesn’t the wonder of comparative advantage work for consumers in Europe and India? Why do we have to raise tariffs to be reciprocal? In short, why are all the violations of free trade always directed towards the US while the rest of the world gets a pass?
In short, if the WSJ fervently believes in “free trade”, apply your criticism to the most prominent offenders!
That is no way to win a conflict; ultimately, that is Trump’s point.
The US markets are overvalued, and many factors can influence stock prices. Blaming “tariff talk” is a crude and inaccurate simplification to fill air time.
Here is a recent interview with Treasury Secretary Scott Bessent on CNBC that we think is important. He hits a number of important issues.
The government’s fiscal condition is a vital factor influencing the economy and the markets. For that subject, we will direct you to the video below by Arizona’s Congressman David Schweikert. He is one of the few in Congress who seems to understand the extent of our national financial predicament. Please spend a few minutes listening to his dialogue, and you will better understand the gravity of the situation.
