…So wrote Charles Dickens in his famous opening line of A Tale of Two Cities. Dickens wrote this novel in part as a warning and as an encouragement to his fellow citizens of Great Britain not to devolve into indiscriminate mass murder and mob violence as he compared the relative safety and stability of London to the chaos and bloodshed of Paris during the French Revolution. Robespierre’s Reign of Terror scared the hell out of everyone and every nation that was paying attention. There was a better way to answer the grievances of the people.
The Best of Times: Today, volatility is everywhere overseas and in Washington, except in the U.S. economy. Though showing some weakness, it is still expanding with fundamentals that are like Goldilocks’s porridge – not too hot, not too cold, but just right. U.S. Gross Domestic Product is marching forward in the range of 3% annualized for 2018, something not seen since 2005. This is a 50% acceleration from the 2% or less that was customary for several years. This rate of growth, even if it slows to 2.5%, will keep the labor market strong and support rising wages. With the help of low energy prices, real disposable income will remain solid. Inflation and interest rates are falling and corporate earnings remain strong.
U.S. corporations are enjoying a permanent tax cut from 35% to 21% which has produced a tremendous boost to their earnings. I disagree when others say the benefit of the tax cut will fade in 2019. Yes, as we compare 2019 earnings to 2018 earnings it will not look as good as it did comparing 2018 to 2017. 2018 was the first year the tax cut went into effect. But the enormous tax savings for corporations will continue in 2019 and beyond. The U.S. economy, while slowing, is still in expansion mode. Slower growth is still growth, and while the Fed is raising short-term interest rates, U.S. consumers and corporations continue to enjoy historic low interest levels.
The 2018 earnings growth rates for the S&P 500 are historically high and should have supported a strong stock market gain: Q1 +24%, Q2 +25%, Q3 +26%. The corporate tax cut accounts for more than half of the earnings growth, but ignoring the tax cut, the growth is still in double digits. U.S. retailers just enjoyed their best holiday sales in six years, and the average American credit score as reported by FICO has hit an all-time high of 704! With the December jobs report released on January 4, we have notched 99 straight months of job growth. The report came in at 312,000 new jobs added, more than double what some economists expected. Average hourly earnings increased by 0.4% in December and bumped up to 3.2% for the calendar year 2018. This jobs report blew out any chance of a recession in the foreseeable future. What’s not to like?
The Worst of Times: What caused the U.S. stock market to fall in a year of strong economic fundamentals? After a strong gain in January the market fell precipitously in February, which is the exact time that President Trump began talking earnestly about tariffs and began executing tariffs. I believe that tariff talk and tariff activity against our strongest allies and our adversaries is the primary reason for the negative markets in 2018.
Tariffs are taxes paid by consumers, and when you tax consumption, you get less consumption. I give President Trump credit for the corporate tax cuts and cutting red tape in terms of regulations. I wish he had left it there and continued to enjoy a rising stock market instead of declaring himself “Tariff Man.” The tariffs are under-cutting his positive accomplishments of 2017. I agree that China must be confronted and punished for its long-time practice of stealing intellectual property. But we would be more effective if we were negotiating with China as a team with our allies. Unfortunately, teamwork is not the way of President Trump.
The U.S. and China are both hurting from the trade tensions. The drop in sales for Apple was contributed to by the trade conflict. And it is not just Apple. The drop in U.S. manufacturing was also contributed to by Trump’s indiscriminate tariffs on aluminum and steel, which have increased costs for U.S. manufacturers and consumers. The costs of these metals are way up and U.S. manufacturers are forced to cut back. President Trump and President Xi are feeling great pressure from their economies and markets to cut a deal.
The stock market turnaround in early January was helped by the blowout jobs report for December and by dovish comments from Fed Chair Jay Powell at the American Economic Association annual meeting in Atlanta. Powell emphasized the Fed’s flexibility about interest rate policy and in selling off the Fed’s huge balance sheet. Nothing is on autopilot, according to Powell.
Finally, I believe the market has struggled because it under-appreciates the strength of the U.S. economy. Recovery is always hard, but keeping the faith is a major component of success.