The big news yesterday was the market decline after the announcement of U.S. tariffs on Chinese goods. As we saw with the previous round of tariffs, markets are pulling back and forth between the very real potential damage a trade war could cause and the likelihood that one won’t happen.
A rational response
As such, the pullback we saw yesterday—while certainly disconcerting—is in line with a reasonable set of assumptions about the probability of a trade war combined with the likely effects on corporate earnings. It’s impossible to come up with detailed and provable estimates of both factors. But reasonable, educated guesses yield something like the pullback we saw. In other words, the market response was rational.
Why does this matter? Because it gives us some guidance on what is likely to happen in the future. The estimated damage from a trade war is not likely to change that much, so the metric to watch here is the chance of one happening. As the market perception changes, we should see a proportionate response in stock prices. This is, again, consistent with what we saw in the last round.
When you look at the markets, however, it is not just tariffs that are having an effect. Indeed, tariffs are just one example of what I am calling “changing fundamental trends.” In this case, the global trend toward an open, multinational system is increasingly changing—and not just for the U.S. Other changing trends include monetary stimulus, as the Fed is now actively shrinking its balance sheet and raising rates; corporate share buybacks, which look to have peaked last year; and spending growth, where both consumers and business seem to be pulling back.
It is not that any of these trends have turned negative. Growth continues, but that growth is no longer accelerating but decelerating. You can visualize this as sitting on a roller coaster as it reaches the peak of that first hill. Before, you could see more track ahead of you. But as you approach the drop, suddenly there is nothing there.
That may be overstating it a bit. We are still growing, and those positive trends remain intact. But more and more, the data and the news represent something to worry about, rather than something getting better. That is a meta-trend, if you will, which is relatively new and which concerns me.
As good as it gets?
I am headed to a Commonwealth conference this weekend, where I will be giving a talk titled, “As Good as It Gets?” At the risk of giving away the punchline, I suspect the answer is close to yes. Confidence and many other measures are at decade-plus highs, and there simply is not that much more room for improvement.
Unfortunately, there is a lot of room on the downside for those indicators. Events like trade disputes, even if they don’t rise to the level of a trade war, can shift sentiment that way. Stock market volatility can do the same. Higher oil prices, which we are now seeing, ditto.
Watch the signs
The trend for all of those factors, and many more, has been to keep getting better—“That trend has been our friend,” as the saying goes. But I am getting more and more worried that might change. The signs that it is changing are multiplying. We are not there yet, but the chances keep rising.