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“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 CPI for durable goods, shown as price level. There is no visible impact of 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 2022. 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 trading at very precarious levels. They’re very vulnerable for a major 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 benefits of sorting out the US fiscal mess and of increasing manufacturing in the US.
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The post Will Economic Detox Lead to a Recession? Maybe Not. But a Long Deep Stock Market Rout Will (See Dotcom Bust) appeared first on Energy News Beat.
