It’s been a tough month for stocks. Assuming no change today, it will be the worst month for equities since 2022. Consumers are in a foul mood as measured by two key consumer confidence surveys last week. Corporate managements are confused. When confused, they defer investments until they regain clarity. Americans have become reticent spenders. None of this inspires optimism. We buy stocks because we believe the companies we invest in will grow. As the economic rules of engagement change with massive announced layoffs in the Federal government and the specter of significant future tariffs just around the corner, concern rises. Sounds almost apocalyptic. But is it?
Let’s begin at the core. We’ll get to bloated bureaucracy and tariffs in a moment. But the core begins with the basic problem that the Trump administration inherited, namely huge projected deficits and a debt load so large and growing that it threatens to choke off the ability of government to provide services in the future. Whatever the Trump formula may be to bring down the deficit and rein in spending, what’s key is that he gets the job done.
He has three tools; tariffs, a reduction in the size of the Federal government, and tax reform. In the Trump game plan, tariffs and tax reduction are offsets while DOGE will reduce the size of government as quickly as possible.
Tariffs come about in Trump’s scheme because he sees trade imbalances as a major inhibitor to our nation’s ability to grow. A majority of economists and investors disagree. For one, trade imbalances only measure the flows of goods. Large American companies are global. They profit by providing services worldwide. Even if overseas profits aren’t repatriated, American corporations here benefit. Think of the investment bank that manages foreign assets, or the law firm doing multi-national deals. Second, a substantial amount of our imports come from products we cannot provide for ourselves. Our trade deficit with Canada is entirely due to the fact that Midwest refiners import heavy crude from Canada. Excluding the value of Canadian oil imports, we actually have a trade surplus with Canada. Third, what appears to be a simple equation on the surface is often much more complex. Look at the 25% auto tariffs announced last week. Simplistically, putting a 25% surcharge on cars coming from Europe, Japan and Korea would seem to favor the Big 3 U.S. companies. So why did GM and Ford stock slide on Friday? Because a substantial percentage of the cars they produce are either assembled in Canada and Mexico, and because a significant percentage of parts come from foreign sources. Not to mention the fact that aluminum and steel tariffs already in place hit the auto makers more than any other industry. On top of all this Trump threatens the U.S. companies with future pain should they raise prices.
To understand the Trump methodology, perhaps it is instructive to look at the 54-page game plan presented to Ukraine describing how the U.S. wants to effectively commandeer the management of Ukraine’s economy in return for future support. The game plan is to ask for the world, often in a preposterous manner, and settle for something less, perhaps a lot less. Now apply this to tariffs. The big announcements culminating in last week’s announced auto tariffs may be the big ask. This week, when implementation begins and a program for reciprocal tariffs is unveiled, look for some modification. I would be foolhardy to suggest the changes; even Trump may not know what we will see this week. But the one constant of the last eight weeks is change.
Let’s get back to the three core components to be manipulated to effectuate Trump’s plan to right size our economic world. I just discussed tariffs. They are a cost, a tax. No other way to call them. They won’t lead to nearly as much reshoring as Trump wants because (1) they lack permanence, and (2) no company is going to build a large-scale manufacturing plant here simply due to tariff policy. Taiwan Semiconductor is spending many billions here because the U.S. is the major market for its products. The same goes for Apple#. Tariffs won’t cause reshoring. Strong U.S. growth will be more effective. But what tariffs do is raise some revenue. First piece of the puzzle.
Next comes DOGE. Musk and his team have moved quickly. Yes, the efforts lack empathy, courts have pushed back, and often the cuts have come in the wrong places. There are vast warnings of impaired critical services but so far at least no one is complaining that they haven’t gotten their Social Security checks or tax refunds. But with that said, the math is clear. The Federal government spent $4.4 trillion in fiscal 2019. It is projected to spend $6.8 billion this year. Over a billion of the difference relates to debt service, and additional Social Security and Medicare. But clearly during the Biden years, discretionary and military spending increased appreciably. Musk promises a trillion in savings annualized by July 4, 2026, the 250th anniversary of the birth of America. Even if he gets halfway there, it would be a healthy start. Layoffs of as many as 250,000 workers sounds like a lot, equal to a healthy number of net new jobs created in the U.S. economy each month. But measured against the total Federal workforce of close to 3 million, it doesn’t look quite so evil. Between reductions of spending waste, less bureaucracy, and a reduction of fraud, the targets seem achievable.
Finally, we get to taxes. Trump not only wants to extend the cuts of 2017 but add additions like no tax on tips or Social Security. In his typical hyperbole he boasts that families earning $150,000 or less will pay no income taxes. But clearly, putting more money in everyone’s pocket will provide growth and offset the pain of tariffs. The problem today is that tariffs are happening now and tax legislation is unlikely to pass until later this year.
Thus, there is a logic to his game plan. Without agreeing with all the components (notably tariffs), if Federal spending can be cut enough to offset the short-term impacts of tax reduction and tariffs, there is light at the end of the tunnel.
If. A very mischievous two-letter word. As George Peppard often uttered on “The A-Team”, “I love it when a plan comes together”. So do we all. If the plan works. It’s simply too early to tell. Trump says he is willing to take a modest recession if that is needed to get his plan executed. Don’t believe that! A recession would be a major setback. Because a recession will blow out the deficit. Safety net expenditures (think unemployment insurance) will rise while tax receipts will fall. Nothing will stop Social Security or Medicare from rising. Lower interest rates (the Fed would have to cut rates in a recession) may offer some relief but lower rates would be applied to even more debt. Thus, the bottom line is that tariffs are coming this week, Musk and team will continue to hack away at the Federal bureaucracy while tax cuts will come later. Bottom line: pain before gain, not something Wall Street is going to like.
April looks to be particularly ugly. This week we get a lot of March economic data plus some tariff clarity. The March data should show some slowing but not anything disastrous. The actual number of Federal employees who have actually been terminated to date is still relatively modest, acknowledging that many forced back to work by court order are likely to be laid off over time. Thousands who opted for early retirement will start to roll off later this year and a hiring freeze will help reduce headcount. That suggests March data should be OK, meaning slower growth rather than economic decline. Next comes tariffs. Perversely, there may be some relief if the tariffs suggested last week are moderated or deferred this week. In Trump land, very little is permanent. Finally, earnings season begins mid-month. While earnings themselves will likely be OK, it is almost certain, at least in my mind, that guidance will be tempered, a result of slowing growth and a total lack of certainty regarding tariffs. With that said, only about 20% of GDP comes from core goods, meaning the sum of goods excluding food and energy. We are living in a service world, one that tariffs don’t impact directly.
We may not have to wait until the end of earnings season to feel the full impact. But the news over the next 3-4 weeks is unlikely to be investor friendly. A moderation in tariff policy isn’t a positive; it’s just a smaller negative. The good news comes in two forms. Most of the tariff pain, including foreign retribution, should be on the table by the end of April. Second, investor earnings expectations will be readjusted once we hear from managements during earnings season. If the Trump team takes steps to avert recession, signs of optimism could begin to appear by mid-spring. The S&P 500 is down 5% year-to-date. It seems worse. The NASDAQ is down 10%, in correction territory. The equal-weighted S&P 500 is down just 2%. Corrections aren’t uncommon. Equity prices needed a valuation adjustment and now have to deal with moderated earnings forecasts. Hopefully, the process will be completed in April.
As for birthdays today, it’s time for the super seniors. Herb Alpert is 90. Shirley Jones turns 91 as does “Dr. Kildare” Richard Chamberlain.
James M. Meyer, CFA 610-260-2220