Market Watch - July 27, 2018
Following a steep sell-off shortly after the November 8, 2016 election, the market has reached several new all-time highs. The market is smarter than any of us, comprised of millions of pieces of information, from millions of people and corporations, coalescing all of that information into the price of the market. While sometimes wrong in the short run, the market is never wrong in the long run.
Markets are driven by hope and fear. This market is telling us that currently there is “no fear” of a significant market decline. More importantly, the market looks ahead, and the message is that the economic future of the United States is more encouraging than any other time in our history.
Question: What are the underlying reasons for the market’s positive outlook?
Answer: There are a record number of Americans employed; there are currently 5 million job openings; businesses and individuals are loaded with cash, as are the banks; interest rates are still cheap; and the tax relief package has put more cash into the consumer’s pocket. U.S. consumer spending represents 70% of U.S. GDP; Americans are spending money like never before; U.S. wealth has grown tremendously in the last few years; and the governments current attitude towards simplifying things for business has encouraged businesses to remain in the United States.
Businesses only move offshore because they are forced to by unreasonable union demands, onerous regulations, expensive and unfair zoning periods, and a general lack of cooperation among government agencies. We have not heard anything about businesses moving offshore recently.
Question: There has been a tremendous amount of press on the negative effects of the newly announced tariffs. How will the economy respond to these tariffs?
Answer: In the big picture the tariffs do not add up to much. For example, China shipped $520 billion worth of goods to the United States in 2017. The first key point to remember is that China’s shipments to America represent only 2.5% of our GDP. This economy will absorb the tariffs for exactly what they are—a small bump in the road. The second thing to remember is that it is America’s effort to be treated fairly. Ford is charged a 25% duty for shipping an automobile to China, for example, while cars shipped from China to the United States pay 2-1/2% taxes, a fraction of what U.S. products are taxed by the Chinese.
All tariffs are taxes. Taxes paid on products shipped to China from the U.S. go right to the Chinese government, providing them with a lot of money to build up their military. That is exactly what is happening in China. They are using tariffs on products shipped from the United States to China to improve the leader’s power and lives, and to expand the military.
Question: The government must have influenced this current huge U.S. economic market. Which administration is responsible for our present largess?
Answer: The Bush and Obama administrations huge annual deficits have supplied an enormous amount of cash to the economy. That cash fueled both consumer and business spending which has brought us to where we are today. The Federal Reserve has begun to extract cash from the economy because they view too much cash as inflationary. The results of this retraction of cash in the economy are unknown at this point; however, continued increases in the national debt—this year estimated to be $700 billion—must necessarily be injurious to the economy in the long run.
Keynesian Economic Theory encourages deficit spending during tough economic times, assuming that spending stimulates economic growth. Keynesian Theory further assumes that during boom economic times like these, with high tax revenues, that those tax revenues would be used to reduce the debt. The problem with modern central banks like our Federal Reserve is that they allow continuing borrowing with no requirement for repaying the debt. Historically, that behavior has always led to a currency crashing, followed by a major economic downturn.
Question: The Fed has hinted at a total of four (4) interest rate increases in 12 months. How will those effect future growths?
Answer: Since the president got irritated with the Fed recently, it seems they may back off on some increases in interest rates this year (Federal Reserve Governors are appointed by the President). If they do not, though, this economy should be able to absorb these minor increases in the cost of borrowing. The biggest problems with borrowing costs are not the private sector, which has the cash to meet the interest payments, but rather the federal government. The federal government’s more than $20 trillion in debt costs taxpayers $200 billion for each percentage point of interest charged. A 2% increase in interest rates, therefore, would cost the government an additional $400 billion annually, which they do not have, and would have to borrow. It’s very dangerous when governments borrow money just to pay interest on debt, just as it’s dangerous for us as individuals to manage our own financial affairs thusly.
The Good News
There has not been an era in our history when the outlook for business is better than now. Since January 2017, the Dow Jones Industrial Average has increased a whopping 46%, creating trillions of dollars of additional national wealth. Statistics indicate Americans own about 35% of the world’s assets. Our consumer spending leads the world’s economies, which is why all of our trading partners are attempting to export products to America. U.S. consumer spending will exceed $14 trillion this year, which represents 16% of the world’s GWP (Gross World Product—a combination of the world’s countries GDPs). Looked at another way, 4-1/2% of the world’s population (the U.S.) purchases 16% of the world’s consumer goods.
In addition to our favorable business and employment outlook, America is politically and militarily as powerful as ever. The current administration indicates a strong willingness to ensure the military remains a mighty force.
There is nothing but clear sailing for the U.S. economy “as far as the eye can see”. Fundamentals exist for good long-term economic growth, with real GDP growth exceeding 3%. Consumer spending last month grew by more than 4%. European governments are changing their trade policies with America. The Chinese will, too. Remember Japan in the 1980s and how much they complained about America’s “injustice” when all we wanted to do was change unfair trade balances? Not only did the Japanese get over it, but also, during this whole recent tariff spat, nobody has heard one word from the Japanese. They have figured out how to market products in America. Further, they have put up many new plants in the U.S. employing hundreds of thousands of U.S. citizens.
America will survive the trade disagreements and arguments with other countries over their paying a fair share of United Nations and NATO Assessments. And our economy will prosper over the next 5 years like never before. With continued record increases in employment and corporate earnings, we may expect that the stock market will reach additional record highs.
U.S. wealth has more than doubled since 2008. America’s economic stability has provided commercial leadership since the beginning of the industrial revolution, over 200 years ago. Our leadership in the technical revolution could yield more significant stock market profits the next few decades than all of the profits enjoyed from the Industrial Revolution.
At the beginning of the Industrial Revolution, America was a small economy dominated by the Europeans. Now, at the beginning of the technological revolution, America dominates the commercial world. Our economic power, and position, provides us the opportunity to look forward to outsized profits, and record corporate earnings, for years to come.
Importantly, America’s commercial leadership for the last century has had tremendous humanitarian benefits. In addition to contributing to extinguishing starvation, poverty, and inhumane conditions, we have set up an infrastructure to help educate people all over the world. A huge amount is yet to be done. It is exciting to think about how much more can be accomplished over the next few decades as a result of the efforts of this country, mostly driven by the cash flow of the business community.
Carpe Diem.
George Rauch
July 27, 2018
