While Friday was a nasty ending to the week, we have seen lots of one-day moves, up and down, that failed to extend into a trend. With that said, however, there are increasing causes for concern. Existing home sales are on track for their worst year in two decades. Other economic sectors impacted by high interest rates are also suffering including auto sales and retail sales, particularly those that appeal to lower end consumers. While Wal-Mart reported fine earnings last week, management’s harbinger of a slower first quarter confirms comments from other retailers. A slowing economy is never good for the stock market.
Investors and business leaders also need to constantly parse Trump-speak. A lot of his extreme statements may be viewed as the start of a bargaining process but they also have economic ramifications. If all the tariffs proposed are implemented and stay put for months or years, the impact would be significant. If they are dangled as threats leading to better outcomes, the results would be sharply different. As of now, no one really knows. That might even include Donald Trump.
In the haste to move quickly, he and his DOGE sidekick, Elon Musk make declarative statements one day and walk a few steps back the next. Businesses plan within a framework that defines the rules of the game. When the rules change literally daily, decisions are deferred until greater clarity persists.
DOGE and Trump promise $2 trillion in savings. Adding in the gobs of revenue from tariffs, and the benefits of deregulation leads up to a Holy Grail of lower taxes, greater growth and higher profits. Except even Musk suggests $1 trillion is a better target. And anyone who has followed Tesla or his other business ventures knows Musk tends to either deliver less than promised or he delivers at a much later date.
So far, with all the moves made and firings announced, the reduction in the Federal work force is probably close to 100,000, most of which is made up of those accepting early retirement. Using an average compensation package, including fringe benefits, of $150,000, the direct savings from work force reduction is about $15 billion. Musk claims a much higher number, a combination of exaggeration and benefits that either come from expired programs or contracts, or steps undertaken by prior administrations, not DOGE initiatives. No matter how one slices the actual data to date, a decrease of 100,000 jobs, spread over several months is hardly significant against the backdrop of a total U.S. workforce of over 150 million. With that said, it will put a dent in reports of monthly new hires in the months ahead.
The House is moving to pass an omnibus bill that will set the table for the use of reconciliation for all things economic Trump wants to accomplish, from enhanced border security and increased defense spending to broad tax cuts. The Senate is moving separately to tackle the easier stuff most can agree on first, like border security, while leaving the trickier stuff like taxes for a later date. Trump and his allies in the House think they can shove the whole enchilada through quickly. Few agree. We’ll see.
Against this backdrop, it is no wonder that U.S. equity markets to date have significantly underperformed major stock markets around the world. When that has occurred over the first 45 days of the year since WWII, it usually persists through the end of the year. It is telling that the U.S. underperformance happens while economic and political turmoil persist in the United Kingdom, France, Germany and South Korea. Another factor to consider is the consequences if the U.S. persists in becoming more isolationist, weakening our military, political and economic ties to Western Europe, Canada, Mexico, South Korea, and possibly Taiwan. One of Newton’s laws states that for ever action, there is an equal and opposite reaction. If we distance ourselves from others, withdraw from organizations, abandon treaties, and impose tariffs, the logical question is what do those impacted do in response? Economically, one wouldn’t expect our current partners to race to Russia, Iran or North Korea for support. But stronger ties with nations like China, Saudi Arabia, Brazil and Japan are likely considerations.
Back to equity markets. If turmoil brings indecision, whether at the corporate or individual level, then projections of mid-teens profits growth for U.S. corporations will have to be toned down. Declines in interest rates last week relate to weak economic data and a flight to safety during Friday’s rout. Declines related to lower inflation expectations would be more satisfying. Yet surveys released last week suggest inflation expectations are rising, not falling. Simply said, when lower yields are a response to a weakening economy, that isn’t a catalyst for rising equity prices.
There are bright spots in the economy to be sure. Tech spending is still strong. Nvidia reports earnings later this week. Reaction will be key to near term performance of Nvidia and its AI cohorts, but also to the entire market. If there were to be a significant correction among the large cap tech names, it is unlikely the overall market could move higher without a significant improvement in the GDP outlook. But robust capital spending plans from the largest technology firms to support AI inference and reasoning advances suggests robust demand for Nvidia chips. We’ll learn more Wednesday after the company reports earnings.
There are other pockets of strength. Consumers are still spending on experiences. Travel is still strong. Unemployment is still low. Job security among non-Federal workers is high. I don’t see a recession brewing. But tariffs, much lower immigration and all the uncertainty defined in this note suggest growth in 2025 will be slower than over the past 2-3 years. As always, the key is 10-year Treasury yields. If they remain near current levels, even if profit growth is lower than currently expected, stocks can do well for the year. But it is going to take time for the dust to settle.
In summary, we are probably in a world of a few steps forward followed by a step or two back until the dust settles. The last month may seem like forever but the chaotic extremes have to moderate. Perhaps an enlightening example is the reaction to Musk’s “request” that all Federal employees submit five bullet points summarizing what they did last week. Pushback has come from newly appointed agency heads as well as from employees who don’t fully understand the requests or the consequences of non-compliance. As the internal pushbacks moderate, investors will be able to observe a clearer path forward. Assuming the Trump administration doesn’t do too much early economic damage, expect a volatile and rocky next few months with some extreme days like Friday followed by a calmer and, hopefully, rising equity market paralleling rising earnings in the second half of the year. Assuming growth moderates a bit, expect better equity performance from non-cyclical growth companies versus companies whose fortunes depend on overall economic growth.
Today, Delaware rocker George Thorogood turns 76. It is also the 70th anniversary of the birth of Steve Jobs.
James M. Meyer, CFA 610-260-2220