“We’re focused on the real economy,” Bessent said. “Ouch,” stocks said. Where did the Trump put go?
By Wolf Richter for WOLF STREET.
One issue is, how do you get an economy addicted to government deficit spending off this drug?
Another issue is, how do you get Corporate America addicted to cheap labor overseas off this drug?
The US has two huge structural deficits: The fiscal deficit and the trade deficit in manufactured goods – the “twin deficits.” Both are massive long-term problems and need to be addressed by sending the economy and Corporate America into “detox,” as this is now called, but it’s going to ruffle some feathers, especially of stocks.
And a third issue is worming its way into the detox conversation: The stock market has gotten addicted to the government’s deficit spending, to the fat profit margins from offshoring production, and to the Fed’s erstwhile free-money policies, including trillions of dollars in money-printing, of which $2.2 trillion have so far been un-printed via QT.
They’re saying the right things, but it’s OUCH for stocks.
“The market and the economy have become hooked, become addicted, to excessive government spending, and there’s going to be a detox period,” Treasury Secretary Scott Bessent told CNBC last Friday.
“There’s going to be a natural adjustment as we move away from public spending to private spending,” he said.
When asked if “detox” was a euphemism for a recession, Bessent told CNBC: “Not at all. Doesn’t have to be because it will depend on how quickly the baton gets handed off,” he said. “Our goal is to have a smooth transition.”
“If you start looking at micro horizons, stocks become very risky”: Bessent.
“We’re focused on the real economy,” Bessent told CNBC on Thursday. They want to “create an environment where there are long-term gains in the market and long-term gains for the American people,” he said. “I’m not concerned about a little bit of volatility over three weeks.”
“The reason stocks are a safe and great investment is because you’re looking over the long term. If you start looking at micro horizons, stocks become very risky. So we are focused over the medium-, long-term,” he said.
“I can tell you that if we put proper policies in place, it’s going to lay the groundwork for a both real income gains and job gains and continued asset gains,” he said.
So where the heck is the Trump put?
“There’s no put,” Bessent said. “The Trump call on the upside is, if we have good policies, then the markets will go up.”
Trump agreed. They’re singing from the same hymn sheet. “You can’t really watch the stock market,” Trump told Fox News last Sunday.
“Markets are going to go up and they’re going to go down,” Trump said on Tuesday from the Oval Office.
Tariffs might cause “a little disturbance, but we’re OK with that”: Trump.
“There will be a little disturbance, but we’re OK with that. It won’t be much,” Trump told Congress to address the side effects of imposing tariffs to encourage companies to manufacture more in the US. Fact is, modern highly automated manufacturing provides huge and important long-term benefits for the economy, including secondary and tertiary benefits.
In terms of the inflationary impact of tariffs, Bessent said that inflation is defined as a persistent increase in prices across a wide variety of goods and services over time, but “the tariffs are a one-time price adjustment.”
How much of that adjustment will make it all the way through to consumer prices is unknown. Automakers, including BMW, have already said that they will have to eat the tariffs because they cannot raise prices without losing sales. That’s why they hate tariffs so much. They wouldn’t mind tariffs if they could pass them on.
That’s what happened last time; they tried to raise prices, but then lost sales and had to roll back those price increases. Inflation is measured by transaction prices, not fantasy sticker prices, and when people don’t buy at higher prices, but buy from a competitor at lower prices, it’s the actual purchases from the competitor that go into inflation measures.
Consumer durable goods would be hit the most by tariffs. This is the CPI for durable goods, shown as price level. There was no visible impact from tariffs in 2018 and 2019:
Even if a portion of the tariffs will get passed on to consumers, given that the economy is now in an inflationary environment, that portion, as Bessent said, will be a one-time bump.
When will a stock market rout trigger a recession?
Tariffs are a tax on corporate profit margins that may be difficult to pass on, so tariffs hit stocks, and they did last time: The S&P 500 tanked 20% in 2018. But it didn’t trigger a recession last time, not even close.
But last time, inflation was below the Fed’s target, and the Fed pivoted in December 2018 when it suggested that the rate hike might have been the last one in the cycle, and it was. That was the Fed’s put perhaps. And Trump had been hyping the Dow incessantly, and he had been keelhauling Powell on a daily basis publicly to end the rate hikes and stop QE. That was the Trump put.
But this time around, inflation is well above the Fed’s target, it’s sticky and stubborn and over the past six months has been accelerating again, and the Fed pivoted at the December meeting from rate cuts to wait-and-see.
At the same time, Trump and Bessent are brushing off concerns about the market: They’re going to fix the real economy, and they’re going to fix the US fiscal nightmare – I mean, good luck, but that’s what they’re saying – and detox can be painful, and so be it.
There is a huge amount of recession talk once again, just like there was in 2022 and 2023.
For the NBER to call out a recession, there would need to be a broad-based economic decline (not just slower growth) and a decline in the labor market.
Measures of the labor market, including weekly measures, are doing just fine. Real GDP growth in Q4 came in at 2.3%, higher than the 15-year average for the US. It was driven by very robust consumer spending growth. In January, retail sales always plunge from December, and huge seasonal adjustment factors are used to iron out the spike in December and the plunge in January. Year-over-year, which eliminates seasonality, January retail sales jumped 4.8%. But seasonally adjusted, from December to January, retail sales declined by 0.9%, likely due to slightly off seasonal adjustment factors (I discussed this here).
But one thing we know from the past – and this may be even more the case now – a stock market rout after a majestic bubble, if deep enough and long enough, will trigger a recession.
We saw that during the Dotcom Bust. The S&P 500 plunged 50% and the Nasdaq plunged 78%, and it triggered a recession. In parts of the US that are depending on the stock market, it triggered a hard recession. In other parts of the country, there was barely a ripple. And it averaged out into a run-of-the-mill national recession.
The biggest spenders – the people with the money to spend freely – always have a large impact on consumer spending. But they also have a large impact on business decisions.
Their wealth is largely tied to stocks, outright company ownership, cryptos, etc. When they lose 30% or 40% or 50% of their net worth, they’re going to get nervous. This includes people with regular jobs, 401ks, and stock options, and people who are business-decision makers.
Many of them have been irrationally exuberant about their stocks and cryptos and real estate and whatnot, after years of huge gains. And if they watch their wealth go up in smoke, they might react, and their decisions move the needle in all kinds of ways:
- As households, they may spend less extravagantly (the reverse “wealth effect”), which will ripple through the economy as businesses react with less investment and spending, and with job cuts.
- As business decision makers, they may batten down the hatches of their businesses: cut spending, cut investments, reduce hiring, and increase layoffs.
For these reasons, a deep sustained rout in the stock market will eventually trigger that recession. But where is the line?
Will the S&P 500 have to drop 40%? 50%? And for how many years? The Dotcom bust took about 30 months to play out, from mid-March 2000 until early October 2002. The rout sandwiched a recession from March 2001 to November 2001. It took a year after the recession ended for stocks to finally bottom out.
Now, stocks are priced at very precarious levels. They’re very vulnerable to a drawn-out rout. And the puts that the market had assumed were there to provide a floor may no longer be there.
And maybe there won’t be that kind deep drawn-out stock market rout of the type that occurred during the Dotcom Bust. And then there may not be a recession at all.
But even if a stock market rout comes along that is deep enough and long enough to trigger a recession, that short-term price may well be worth paying for the long-term risk-reduction that comes with sorting out the US fiscal mess and for the enormous long-term benefits of increasing manufacturing in the US.
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I so agree with this for all Americans and their next generations.
I don’t think Trump has lied about his intentions, in fact he has been very transparent. Probably the most transparent President in my lifetime. Obama and VP Biden promised to cut fiscal waste, but never really followed through.
Concur. The thing that puzzles me is Trump and his familys crypto push. The meme coins – was that to kill that market? Strategic reserve holding bitcoin seems kind of dumb, what is the point? I get that a treasury issued stable coin on a blockchain would be good for tracking all federal payments. All the rest seems dumb to me. Maybe bitcoin was just a giant govt scheme to crowd fund the brute force method to break the highest levels of encryption, who knows?
Classic vote-buying.
Man there any real hope of fiscal sanity? Feels like the the horse has left the barn and endless inflation is the classical fate of nations like ours historically.
Dalio was suggesting this: (but seems a bridge too far. I’m 55 and remember quasi sensible
politicians on both sides and seems a very long time ago since I’ve seen even and inkling of a fragrant bargain. Almost like they know the ship has sailed fiscally so now focused on blame-storming – plenty to go around. Oy.
To achieve the goal of stabilizing debt relative to income, it would take about an 11% increase in taxes, about a 12% cut in spending, or about a 3% cut in interest rates
What are the long-term benefits of increasing manufacturing in the US? I thought that manufacturing, largely automated, created few jobs and it is a small margin activity anyway. Isn’t it commoditized?
Good grief. Do you really don’t know? Has America fallen this far already? Highly automated manufacturing is possibly the best thing that can happen to an economy. It requires high-tech skills to design, build, and install the equipment, then to operate, maintain, and service the equipment. These are specialty jobs and expertise, including software engineers. It requires high skill levels to plan the plant, build it, etc. All of which generate secondary and tertiary activity of specialized companies. Then there is all the activity around supplying the plant with components and materials. Manufacturing generates investment in construction of buildings and infrastructure. It triggers investment in electricity generation and transmission, so the construction of more powerplants, etc. It requires education and training of the specialized workforce. It generates knowhow that gets lost when you abandon manufacturing, and then you cannot do it anymore.
To get a large semiconductor plant up and running, from a cornfield to full production, including equipment, requires about $20 billion – that’s a huge amount of economic activity, and that’s just the beginning of it before actual manufacturing starts, and that’s not even counting all the other activity around it such as selling cars, laptops, smartphones, sandwiches, etc. to the people that work on and in the factory.
Manufacturing generates a large amount of taxes, including local taxes. That’s why states and municipalities are trying so hard to get a company to build a manufacturing plant in their area.
And supply chain security and independence from foreign interference to the economy. Of course, apolitical economists won’t care about these.
Yes, strategic reasons are crucial in all of this. The US economy can be strangled by China, as we have seen during Covid. Chip manufacturing in the US is absolutely necessary for strategic reasons.
that is all fine and dandy if you actually collect taxes on that manufacturing; what happens in practice is that municipalities race to the bottom with tax breaks and incentives, then those profits are passed on to shareholders largely tax-free
You’re right about that. Municipalities absorb most of the costs of all the transportation and utility infrastructure necessary to keep the company in business. And even worse, these companies pay very little in federal taxes either….all the while continually threatening the municipalities with a pull out and moving someplace else if corporate demands are not met.
Have you ever seen a town where all the companies left?
They do this because it creates jobs, which makes people want to live there, home values increase, property taxes increase, restaurants and small businesses open to support the population is living it that area for the jobs.
Looks like a lot more than 30 months Wolf?
”Will the S&P 500 have to drop 40%? 50%? And for how many years? The Dotcom bust took about 30 months to play out, from mid-March 2000 until early October 2022. ”
Re: recession, sooner the better and get it over with; how some ever, there is not any way to ensure the medicine will be sufficient or last long enough due to the indifference of the politicians of all stripes to spend other people’s money!
Why not ease capitalization rates instead of imposing tariffs?
The Trump put is still there, it’s just a bit out of the money still.
Many thanks for connecting dots so cogently. I have read plenty of books that prattle on for 300+ pages and say a lot less. For my part, I am still holding a relatively small allocation of stocks, hoping to cross the gap to the other side of this.
1. Dot com bubble was so 2001. Back then, mostly telephone based brokers. Very little computer-Algo based traders.
2. This time its different. Now everything is internet, automatic and computer based.
3. Housing was not connected to stocks back then. So, even during 2001 housing was solid. So many industries are now connected to stocks.
4. no QE in 2001. The rates 6% were so high compared to 4.25 now. FED are less independent and chicken now.
5. 401K based passive investing was still recent in 2001. but now everything and everyone is in the stocks.
6. Cryptos are also in the mix but its difficult to explain
7. 2025 is going to be crazy. I predict based on astrology, that bubbles with start popping from March end – April to summer.
1. I was trading online through Fidelity in 1998. I can’t imagine most people were still calling a broker, which I did circa 1992, in 2001. During that time I remember online trading being hyped far and wide.
4. The Fed Funds Rate started 2001 above 6%, but went straight down and ended 2001 at 1.82%, much lower than today. There was no QT in 2001 either.
5. The bottom 50% of Americans by net worth own about 1% (Q3 2023) of equities and mutual funds. So not everyone and anyone is in stocks.
As a resident of San Francisco’s wsoma area for 25 yrs I know about addiction/addicts and detox/rehab/recovery. Addiction to anything, drugs, drink, gambling, AND debt is nearly impossible to kick. Debt addicts can file for bankruptcy and perhaps can again engage in their addiction, the question at hand is will our elected officials do anything about it. I seriously doubt they will. The USA will go the way of Rome, England and other nations once rich and mighty and now mere whispers of what once was.
Awesome, Wolf. Thank you!
Adds:
3rd detox restated. Thinking that micro rate changes is a means to run a complex economy is absurd. Thinking that it’s responsible to leverage, after the fact, big bailouts and handouts, is dangerous. The detox fix is bringing the monetary policy back to long run stability. Rates determined by a combination of inflation, taxes and return. And severe debt to GDP limit controls. And preventing screw ups, like dotcom & subprime, with early on regulations and/or enforcement.
The 4th detox, is politicians. They need a daily dosing of accountability. And more skills that are focus on running governance in public interest. Not unique to USA. An issue for hundreds years. But it’s the crux of what tanks empires. Leadership.
Politician accountability such as: Full audits on spending and politicians. Clear reporting. Illegal to make promises that are not pre-funded. Fixed & balanced budgets. Recall for incompetence. Jail for corruption. Reduce debt to targets on GDP. Goaks snd meadures; stick to esssentials. Bring on real jobs. Stop free riding handouts and bailouts. Get more efficient; measured. Separation from insider trading and donor benefits. Their focus is American people.
This 4th is a bigger chalkenge than the other three. However were here by prior political lesdership. And ~75M voters want the swamp drained.
Otherwise, it’s rinse repeat.
If I had 10 more years it would be the buying opportunity of generations. The markets are way overvalured by any measure, will correct 30 – 50 percent, and all the hype about growth is just that, without a ten year track record.
Pity the fools in funds as that is where losses come from. Classic sell on the way down and buy on the way up, while smart money trades. How is AI, latest chip, or coins working out for newbies?
Howdy Youngins. Balanced Budgets
1000 Year Republic
The biggest difference this time is EVERYONE is invested in risk assets.
Most are relying on the growth for there retirement plus a large amount of boomers retiring… Messy!
I think they are underestimating the timeframe it could take for assets to recover.
Japan 1989-2003 repeat isn’t out of the question IMO
I like to add little tidbits from our business to color the tariff conversation. Truck equipment is ground zero for the negative impacts of NAFTA.
The majority of the production of what we make has now moved south of the border, little by little. Some of the parts in the industry are coming from India and China.
American producers of our product niche, like us, are clinging to maybe 20% of the market, collectively. The market is still sliding south but we are not going down without a fight.
The last few years have seen us pour 100% of our free cash, and a little extra debt back into the business…why? Robotics. We have redesigned products, retooled production lines, and purchased highly productive and accurate CNC equipment. We see this as our only hope to stay competitive with a midwestern US factory.
All business is essentially the purchase and sale of labor in different forms from different parties. Labor is roughly $30/hr more expensive here compared to Mexico for several reasons, mostly linked to the quality of life that American citizens enjoy. Given the hours in our product, this result in the border jumpers having a cost advantage of 10-15%, all else equal. This advantage whittles away at our ability to thrive over time – an engineer here, a sales team there, a new machine…eventually that extra margin allows the competitor to steal all the market share if they use it wisely.
Does the ROI cleanly pencil out in favor of these robotics investments? Probably not. But the business is what supports our family. And we have no choice but to try everything we can to keep it working, within reason. Would we have been better off sticking that cash in the stock market? Maybe…we will see.
People who claim these tariffs are nothing but a net negative tax on consumers are 100% dead wrong. There is a boat load of gray area. There are positives and negatives. I say these tariffs are a tax on the gross margins of our competitors, whose labor arbitrage siphons wealth out of America.
If the tariffs stick, our customers do not have to instantly pay more forever. They will have a strong economic incentive to shop local and they will find us and a few others standing ready to take production back to the American Midwest. To do that, we will need more machinery, more trucking, more metal, and more employees. It will improve our ability to pay our workers a living wage. The loss of this activity has hollowed out the middle class.
Our facility can double output with a little work and some more employees. The fixed cost absorption of better utilizing our capital will actually allow us to sell more cheaply than today and make a reasonable profit.
To some extent, the opportunity to offshore production disincentivizes investment in American factory productivity. I would argue that option to outsource is the primary driver of weak productivity growth of the last few decades.
Maybe some domestic companies will kick back and raise prices and collect those sweet tariff margins. Our business will NOT be doing that. That would be wasting a golden opportunity to put some Ws on the board for a change.
I don’t know if this still holds true, but I have heard this both from college finance professors and family who retired very early off of trading the energy crash in the 90s (I think) and then successfully supported themselves for the last 30 years with that money. The advice I was given was you can always tell a market top because every individual investor with no finance background thinks they’re an expert and has a tip for you. I heard this was especially true of the .com bubble.
Well my hairstylist spent my whole last appointment giving me crypto tips and investing advice, my workout buddy was giving me options trading tips yet didn’t understand when I was saying well the diff between buy and hold is that the market eventually comes back up but with options you deadline for that market recovery, and my yoga instructor friend told me 20% year over returns were normal and that I was missing out by having my savings for a house in bonds. This was in the last 2 weeks. I’ve heard a lot of these comments lately and when I ask questions that would just require a basic understanding of finance I get a confused look.
It will be interesting to see if this bubble actually pops.