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Has the US economic miracle come to an end?

October 2018

The volatility in markets this week appears to have been caused by a belief that the US economic miracle is about to come to an end. Trump only has himself to blame

  • The catalyst for the sell off seems to have been some weaker earnings in key US companies and a concern that the US economy is rolling over
  • Trump has played fast and loose with the US consumer, who is feeling the effects of his international policies
  • Anyone can cut taxes and boost GDP in the short-term, but markets are wise to the ultimate consequences of these tactics

It has been an ugly week on Wall Street. At the time of writing, the S&P 500 has fallen for the sixth straight day and is down around 3%. The catalyst seems to have been some weaker earnings in key US companies and a concern that the US economy is rolling over, but there are other issues such as the trade war and mid-term elections to keep investors worried.

It’s not like we weren’t warned. Plenty of commentators have warned that US stock market leadership was too narrow, the valuations of key technology stocks too high and the market looked like it was reaching its peak. Sure enough, it is the tech-heavy Nasdaq that has been hit hardest, falling over 12% from its 29 August closing high high. Recent falls put it firmly in correction territory. Amazon, Facebook and Apple have now all seen significant drops.

It is difficult not to see the chaotic US administration as part of the problem. Trump’s tax cuts came at a time when the US economy was already doing well. He believes the tax cuts will pay for themselves as the economy grows. However, as Guy Stephens, technical investment director, at Rowan Dartington points out: “He believes that if you cut corporation tax from 35% to 21%, as he has done, then the subsequent reduction in the exchequer corporation tax receipts of 40%, which is a huge number, will be ultimately offset by higher receipts as the lower rate of 21% will be based on a much bigger economy as growth surges. 

“In fact, for that to occur, ignoring the other income tax cuts and spending commitments that he has made, then the US corporate economy will have to increase by two-thirds for the same tax receipts to be realised. Spread that over ten years and you would need an economic uplift of over 5% a year to recoup it back.”

Retail sales are notably weaker. This was always likely to be a problem as the trade war raised the price of goods for US consumers. They are also being hurt by the higher oil price, another Trump-inflicted wound, as he imposes sanctions on Iran. Trump has shown himself relatively careless with consumer sentiment, in spite of its importance for the US economy. 

At the same time, the trade war is hurting manufacturing, which is being seen in weaker earnings for key industrial names. Caterpillar and 3M, for example, have been notable casualties.Caterpillar has lost 21% of its market value this month as tariffs have raised metal prices and trade frictions have created problems in its end markets.

The trouble is, any government can cut taxes and hike spending to win short-term voter support. Politicians used to do it all the time, until they grew up and realised that the aftermath is burgeoning budget deficit requiring periods of uncomfortable austerity.

Trump will undoubtedly blame the Federal Reserve, or the accounts guy, or China, but as Stephens concludes: “In the UK, capitalist governments tend to cut taxes and cut spending whilst socialist governments tend to increase taxes and increase spending. Trump is cutting taxes and increasing spending – surely a recipe for trouble for tomorrow.”

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