By Mark Armbruster, CFA
To watch the news these days is an exercise in negativity. Maybe that’s not a new phenomenon, but it seems particularly bad on the economic side these days. The “experts” are all forecasting doom and gloom thanks to new policies on government spending and tariffs. We’re sure there is some truth to their arguments, but we also find a lot of it comical since many of the loudest voices are on record supporting government cutbacks and trade protections in the past.
A lot of what we’re facing economically is presented as partisan and overly political. We’re not sure that’s true. The U.S. government and governments worldwide have overspent for way too many years. That isn’t really debatable. The debt-to-GDP ratio, which we’re fond of watching as a barometer for future economic growth potential, is 124%. That’s a high level, well above the 90% that academics have cited as the upper limit before growth stalls. While we can continue to issue debt in our currency without worry of default, that doesn’t mean there are no consequences to our indebtedness. Japan also issues debt in its currency. It has a debt-to-GDP ratio of 263%. It may never default on that massive debt load since it can print more money, but the Japanese economy has stagnated for over three decades. That’s not the future we want, regardless of which political party controls our government, and both are complicit in running up the debt.
The trade deficit is another issue that shouldn’t be political. While the media and academic economists’ rail about proposed tariffs, we’ve seen videos of Chuck Schumer, Nancy Pelosi, and Bernie Sanders all advocating for trade protections during prior administrations. Former President Obama put a 35% tariff on China in 2009. Warren Buffett wrote an article for FORTUNE magazine in 2003 detailing the magnitude of our trade deficit. He described it as “selling the nation” since all the money we ship out to buy foreign goods comes back to purchase our companies and real estate, slowly impoverishing our nation. His proposed solution was a “tariff called by another name.” So, even those directly opposed to our current leadership have advocated for similar remedies in the past —not a partisan issue.
We’re in favor of any administration at least starting to address these issues. However, the current one is carrying out their initiatives in true Trumpian fashion. That is with erratic communication, ham-fisted implementation, and a combative attitude toward the media reporting on their work. With a little more finesse, the impact we’ve seen on the stock market likely would not be quite so nerve-wracking. That said, expecting a leopard to change its spots is unreasonable, so we probably have another three and a half years of potential volatility. As for the economic impact and what that will mean for stocks, there are several considerations.
We expect economic growth to subside in the short term, at least on paper. That probably means a recession is coming. Government spending represents roughly one-third of economic growth. So, cutting that back could cause economic growth to decline, even if government spending needs to be reined in eventually. If and when the recession arrives, expect negative headlines about President Trump’s failing policies. But as the old saying goes, you’ve got to break a few eggs to make an omelet. We’re not sure that the coming recession will result in a broad-based downturn, even if growth stalls according to the official statistics. After all, if you pay one guy to dig a hole and another to fill it in, nothing productive has happened, but they still add to economic activity. Removing that activity from the economy may be recessionary, but it doesn’t directly impact the productive economy. The latest employment report showed many layoffs in the government sector but a robust job market in the private sector. Therefore, an economic slowdown could be shallow, short-lived, and limited to a relatively narrow section of the population.
Looking ahead, economic growth could expand even faster if we reduce government debt, remove regulations that impede corporate profit growth, bring jobs back home, and reduce taxes. That could set GDP up to grow above its current long-term potential.
What about inflation? Won’t tariffs drive up prices? They may, but likely not across the board. Economist Milton Friedman teaches us that inflation is tied to the amount of money in circulation. It is more complex than that, but widespread inflation generally only occurs when a large amount of government money is printed or interest rates are held artificially low, the proverbial too much money chasing too few goods. Most recently, we saw that in the wake of COVID, when inflation rose 9% at its peak because of excessive government spending.
If prices do rise on some goods, that will hurt consumers. However, we believe the media is missing what will likely be another key part of this administration’s economic policy: tax cuts. If prices rise by 5%, but your tax rate goes down by 10%, consumers are still better off. We have not seen anything definitive about what that tax proposal will look like but have heard a lot of noise about possibilities. These include cutting corporate taxes; extending SALT deductions; making the 2017 tax cuts permanent; eliminating taxes on Social Security, tip income, and for those making under $150,000 annually; etc. We don’t know what to expect at this point, but it seems reasonable that a proposal for significant tax relief will be forthcoming, which should ease the pain of any price hikes.
Interestingly, so far, the experts’ forecasts have largely been wrong. Admittedly, it is still early. But inflation has eased, and interest rates haven’t spiked. The ten-year Treasury yield is flat since Trump took office. There was also a lot of chatter about the dollar’s value rising, which would make our exports less competitive. So far, tariff proposals seem to have caused the dollar to drop. That’s good for our manufacturers, and it’s also good for us as investors since our international stocks end up being worth more to dollar-based investors.
We’ve lived through several true economic crises and bear markets. We’ve watched presidential administrations come and go. The overriding theme is that our capitalist system, no matter how flawed, always finds a way to chug forward. Presidents can have an impact, but generally, things work out ok regardless of who is in the Oval Office, and we expect that this time will be no different. So, whether you love or hate Trump (no one seems to be in the middle), some of his economic policies might actually make sense beneath the chaos.
For more information on Armbruster Capital’s investment management philosophy and approach, contact us via our website, call (585) 381-4180 or email us at info@armbrustercapital.com.