It’s not quite a correction – a 10% decline – yet, but the S&P 500 is down 9.3% from its September 20 peak as of Wednesday’s close. President Trump scores his performance according to the stock market, which has had its worst month since February 2009.
The tech-heavy Nasdaq Index already is down more than 10% from its peak, and both the S&P 500 and the Dow Jones Industrial Average are down on the year.
Lots of things are going wrong, as I wrote on October 11. The Federal Reserve is raising interest rates. Stretched balance sheets at global banks have made it hard for foreign buyers of US Treasuries to hedge foreign exchange risk, putting more upward pressure on Treasury yields, as Asia Times reported in an October 9 exclusive.
The US housing market has imploded with new home sales down almost 20% year-on-year. The first round of tariffs on Chinese imports has raised costs for US manufacturers, as the Fed reported in its October Beige Book on Wednesday.
US corporate profits as reported to the Treasury were down year-on-year in the second quarter, but per-share profits rose due to record buybacks – an unsustainable sugar high. US economic growth is hard to reckon, with the New York Fed’s model projecting only 2.1% growth for the third quarter versus an Atlanta Fed estimate of 3.9%.
One of the biggest sources of uncertainty is the next round of China tariffs, which will raise the costs of inputs to US manufacturers as well as consumer goods, adding up to 1% to the inflation rate, according to most Wall Street estimates.
It is hard to tell how much of the 25% tariff bump will be absorbed by Chinese exporters, how much by corporations and how much by consumers, but it won’t be good for the stock market.
We won’t know how badly tariffs will hit the US economy until the first quarter of 2019, when inventories purchased at pre-tariff rates run out and manufacturers and retailers have to re-order at higher prices. But the impact of the first round of tariffs is already big enough to move the needle, according to the Federal Reserve survey.
US consumers’ budgets already are stretched. A modest rise in mortgage rates has already pushed large numbers of home buyers out of the market, and homebuilders’ stocks are down 35% during the year to date. In fact, most sectors of the US stock market are down sharply.
The only gainers are tech, which took a drubbing on Wednesday, as well as healthcare – supported by increased federal spending – and defensive sectors like utilities and consumer staples.
The stock market’s October plunge should put the White House on yellow alert. The US economy showed strong growth during 2018 in the aftermath of the Trump tax cuts, but the future growth path is uncertain. Missing from the present recovery is productivity growth and wage growth, which leaves consumer budgets fragile.
Nothing would revive the stock market’s sagging animal spirits like a trade deal with China. As I reported on Wednesday from Beijing, senior advisers to the Chinese government are searching for a deal that would satisfy the administration’s concerns about Chinese trade practices and acknowledge American concerns about China’s industrial policy.
China won’t change its economic system to please the president, but it could formally shelve its “Made in China 2025” plan, which is largely a public relations campaign directed at an internal audience.
China doesn’t want a fight with Trump. The prospect of a full-dress Cold War with the United States has spooked the Chinese stock market, dominated by retail investors who tend to cut and run at any sign of political trouble.
China has a lot of wood to chop in its own economic policy. Reform of state-owned enterprises has proceeded slower than the leadership intended, and its flagship Belt and Road Initiative is plagued by poor planning and political frictions with China’s trading partners.
The stock market’s misery gives Trump more motivation to conclude a deal with China, and China is likely to make it easier for Trump to strike a deal, by giving the president a resounding propaganda victory. Rather than focus on a 2025 target for high-tech dominance in fields such as semiconductors, China may be willing to push its program back and quietly dig in for the long haul.
By 2035, Chinese planners believe, China’s economy will be so large that it will not have to worry about American pressure. Its priority is to stay on track for the long term, and it may be willing to give the president what he thinks he wants.
Both China and the United States have a stronger motivation to conclude a deal than they did three months ago. The November 30 summit of the Group of 20, where presidents Trump and Xi Jinping will meet in person, may be the opportunity for a deal that will give both sides an opportunity to regroup and plan for the long haul.