With his trade policy unravelling and political change on the cards, Trump’s best stock market days are behind him
- Nicholas Spiro says recent stock market routs have come at a bad time for Donald Trump, who has linked the success of his administration to the S&P 500 index
- However his party does in the midterm elections, it is unlikely to put the brakes on his populist economic agenda
Until this week, US President Donald Trump had enjoyed a good run with the financial markets.
The benchmark S&P 500 stock index, which Trump uses as a gauge of the success of his administration’s policies, had risen 17 per cent, in contrast to a 3 per cent fall in the pan-European Stoxx 600 index and a 5 per cent rise in the MSCI Emerging Markets index.
Even in the bond markets, which are sensitive to an increasingly hawkish Federal Reserve and its tightening of financial conditions, the yield on 10-year Treasury notes has risen sharply this year but remains extremely low by historical standards. In the corporate debt markets, spreads on high-yield debt, or junk bonds, have shrunk this year.
As I have pointed out in previous columns, the “America first” trade policy has been much more pronounced in 2018.
With the US’ crucial midterm congressional elections less than a fortnight away, Trump will be heartened by a report, due out on Friday, that is expected to show the US economy has just enjoyed its best back-to-back quarters of growth since 2014: GDP growth at 4.2 per cent in the second quarter, followed by a likely 3.4 per cent in the third quarter.
Moreover, despite a surge in stock market volatility this year and a severe slump on Wednesday, Trump can even point to gains in stock prices in the second and third quarters of a midterm election year – bucking a historical trend of losses before midterms that dates back to 1945, according to the Financial Times.
This impressive record has strengthened the Trump administration’s resolve to escalate the trade war with China and emboldened the president to claim credit for the strong performance of America’s economy and stock market.
US-China trade war – day 105 and counting
Yet, as the midterm elections draw closer, the most trumpeted successes of Trump’s presidency – a fast-growing economy and a buoyant stock market – are under threat, posing an acute challenge to the deeply unpopular president.
He faces possible impeachment proceedings if the Democrats win a decisive majority in the House of Representatives.
In the markets, the America first trade policy has been unravelling as part of a dramatic decline in global equities since the start of this month.
The Russell 2000 Index, a gauge of US small-cap shares that benefit most from strong growth because they rely more on domestic sales, lost all its gains for the year on Tuesday.
In its worst month since February 2009, the S&P 500 fell 9 per cent this month, and lost all its gains for the year on Wednesday, according to Bloomberg.
While external headwinds are partly to blame, the fundamentals of the expensively priced US stock market – in particular, the profit margins that have helped fuel the double-digit growth in corporate earnings over the past two years – are being questioned.
On Tuesday, Caterpillar, a US industrial bellwether, warned of rising materials costs, suggesting that trade tariffs are contributing to a squeeze on margins and causing concern that earnings have peaked.
The pressure on valuations is all the more acute given the Fed’s determination to keep raising interest rates despite the sharp slide in stock prices and growing signs that higher borrowing costs are crimping growth, as higher mortgage rates hurt the housing market.
Datatrek Research, a US consultancy, rightly noted in a report published on Tuesday that “the Federal Reserve and US equities are on a collision course”.
Watch: US will ‘suffer more’ in trade war with China, Jack Ma says
Trump is clearly rattled. He has lashed out at the US central bank, claiming it had “gone crazy” and singling out tighter monetary policy as the “biggest threat” to his presidency.
Last weekend, he caught his own Republican Party off guard by pledging another sweeping tax cut – this time for middle-class Americans, in a tacit acknowledgement that his last tax cut mainly benefited large corporations.
If the Democrats capture the House convincingly in the elections on November 6 – the Republicans are widely expected to retain control of the Senate – political risk in Washington is likely to escalate sharply, adding to the strain on US stocks.
Yet if Beijing believes that Democratic control of the House will force Trump to back down in the trade war, it has another think coming.
Not only is the president likely to pursue his nationalist economic agenda irrespective of the outcome of the elections, he will almost certainly take an even more confrontational stance towards his adversaries which, worryingly, now include the Fed.
Even though Trump can no longer brag about a surging stock market, it does not mean his protectionist and populist policies are about to change.
Nicholas Spiro is a partner at Lauressa Advisory.