Market Watch - April 19, 2019
The U.S. economy continues to set records in every area: employment, innovation, productivity gains and patents granted. Few citizens are aware of this, but by June our economy will have experienced the longest era of economic growth in U.S. history without a recession. Statistics show no weaknesses leading to a slowing down of this amazing American economic machine. The stock market just set a new record, and more records are likely to follow.
Question: A few months ago it looked like everything was falling apart with interest rates increasing and the administration arguing with the Federal Reserve System about the Fed’s tightening of interest rates. What happened so quickly?
Answer: The discord a few months ago was not economic, but rather political. After the elections, when things settled down, reality again took ahold. The market sell-off was a combination of political angst, coupled with the Fed’s aggressive interest rate increases last year. The only other president that has publically argued with the Fed was President Regan in the 1980s. The current president’s disappointment with the Fed, and his appointing a new governor who is less likely to increase interest rates dramatically, has had a positive effect on the stock market.
Question: Isn’t the Fed the economic Guru? Aren’t they supposed to know at what point setting interest rates would benefit the economy?
Answer: The reputation of the Fed is that they are the Guru with the answers, but that is completely incorrect. The economy is highly sensitive to interest rates because interest costs are a significant percentage of the cost of doing business. This administration has badgered the Fed enough to dampen the bank’s enthusiasm to increase rates further, or at least, slow down rate increases. The economy has become aware of the fact that the Fed is softening on further rate hikes, and that has impressed the stock market.
Question: Does the president have that much power over the Fed? Will interest rates remain low?
Answer: The president certainly has a lot of power over every governmental institution. Using a crystal ball, though, regarding where interest rates are going, is dangerous in investing. Logic, though, is helpful: Recall that this president has been in and out of bankruptcy court for 40 years. All of Trump’s business issues in bankruptcy have been because of too much debt. We can assume it is in the president’s best interest to keep interest rates as low as possible. As he is human, some serious self-interest must enter into the administration’s desire to suppress further increases in rates.
Question: Is the Fed not operating in our best interests?
Answer: The Fed may feel they are operating in our best interests, and it is hard to believe they are not trying; however, the Fed’s tinkering with interest rates, rather than interest rates being set through the law of supply and demand, has led to all of our recessions the last 40 years: the 1980s savings and loan crisis; the 1990s tech bubble; the 2008 sub-prime housing crisis. Each of those bubbles was created because firms borrowed money at artificially low interest rates that were set by the Fed. Each bubble burst when the Fed increased interest rates rapidly, high enough that the cost of interest caused many companies to fail that might not have in a market where interest rates are set by the law of supply and demand. A majority of Federal Reserve governors have no business experience, but rather, they have honed their economic skills in academia.
Question: The market keeps going up. Some economists say the 2017 tax cut has had little impact and other economists say the impact has been dramatic. Is there a truth here?
Answer: There was an across the board decrease in marginal tax rates, so the tax act did help all filing taxpayers. Mathematically, the corporate tax rate cut from 35% to 21% has been more important. As Todd Castgno at Morgan Stanley recently wrote, “investing in stocks is buying future earnings, and lower taxes mean better earnings”. When the corporate tax rate was announced, individuals and institutions increased buying of stocks in anticipation of better future earnings. That increased demand has been expressed in an increasing stock market.
Question: We have read lately that the dollar is not only very strong but the U.S. trade deficit is at record levels. Can you shed some light on this strong dollar and what might happen if it weakens?
Answer: Big trade deficits and weak currencies go hand in hand. The dollar “should” weaken. There is no answer to this question other than over time the dollar will go down.
Several times in U.S. history the dollar has remained stronger than economic theory suggests it should. The reason is because of the economic power of America and our ability to see our way through recessions. We are the world’s bread basket. We can feed ourselves. We produce our own energy. There is peril around the world all the time. Look at Venezuela; formerly a democratic country; China and Turkey have all been taken over by “presidents” who have become “presidents” for life. Ditto Russia. These regimes are the enemy of freedom and free enterprise. The world’s investors continue to scramble to get their money into safe havens. There is no safer place in the world for money and investments than the United States. There is a huge pool of overseas capital in this country right now chasing investments. This capital is pushing up the cost of assets other than just the U.S. stock market. We should enjoy the ride. Exports last year set a record despite the overpriced dollar being the strongest it has been in three decades. There is no logical explanation for the strong dollar other than the above.
Conclusion:
There is a huge amount of cash flow in this economy, more than ever before in history. Many economists feel we are going into another asset bubble like the 1980s savings and loan crisis, the 1995-1998 and the 2005-2008 asset bubbles. Here we have an interesting disagreement between the bulls and the bears: bulls believe the recent downturn in the stock market was a political blip in an ongoing expansion; bears believe we are seeing the last of a dying bull market. Whether or not this market continues to thrive depends upon future corporate earnings.
On April 18th the DJIA obtained a new high. The market is increasing in anticipation of growing future earnings. The political environment is the best it has been since the Reagan years. U.S. corporate executives have placed companies in a position to compete well in world markets, which is why U.S. exports are setting records.
This is a continuing, and expanding, bull market. U.S. company’s efficient economic performances indicate the economic path for the United States is currently paved in gold!
George Rauch
April 19, 2019
