Trade War and the Fed Threaten Trump’s Buoyant Stock Market

August 7, 2019 Updated: August 9, 2019

WASHINGTON—It has been 1,000 days since President Donald Trump’s election, and during this period, the stock market has rejoiced in his pro-business agenda, setting record after record.

Even after the recent pullback in stocks, the Dow Jones Industrial Average through Aug. 6 was up by nearly 30 percent since Trump’s inauguration and more than 40 percent since Election Day 2016.

Trump’s presidency boosted Wall Street as his favorable policies toward businesses such as tax cuts and deregulation have lifted investor sentiment. Despite the U.S. Federal Reserve’s tightening policy in the last several years and the escalation of the U.S.–China trade war, the stock market’s rise since Trump’s election outperformed the gains recorded during the same period following the elections of Presidents Barack Obama, George W. Bush, and Bill Clinton.

How the market performs in the run-up to the 2020 presidential election will be mostly influenced by the ongoing talks between Washington and Beijing, corporate earnings, and the Fed’s monetary policy, according to experts.

Source: Yahoo Finance historical data

The U.S.–China trade war is hurting the stock market significantly, according to Stephen Moore, chief economist of the Heritage Foundation. “Everyone wants a resolution to this,” he said, adding that business investments were falling because of uncertainty.

Moore noted that the Chinese economy would suffer significantly because of trade tensions, however, “they might take the American economy down with them.”

“If the trade war drags down the economy, that certainly could hurt Trump’s chances of being reelected,” he added.

The stock market tumbled since late last week due to the worries about the escalating U.S.–China trade dispute. Trump accused Beijing of failing to deliver on its pledges and announced a fresh 10 percent tariff on $300 billion worth of Chinese imports, which would take effect on Sept. 1.

In an effort to offset the cost of tariffs, China devalued its currency on Aug. 5. That prompted the United States to label Beijing a currency manipulator, after the Chinese renminbi weakened to its lowest level since 2008, slipping to more than 7 per dollar.

The Fed

Besides the tit-for-tat battle between Washington and Beijing, another important risk facing the U.S. stock market is the Federal Reserve, according to Moore.

“The Fed has to lower interest rates and has to do it immediately,” he said, adding that instead of waiting for the September meeting, the Fed should hold “an emergency session, because global markets are in turmoil right now.”

He said that “commodity prices are falling. We’re on deflation, and the Fed has to cut that off immediately.”

The U.S. central bank announced on July 31 that it would cut its benchmark federal funds rate by 25 basis points, which marked the first easing in more than a decade. The Fed’s decision was widely predicted. However, U.S. stocks fell after Fed Chairman Jerome Powell erased hopes of future rate cuts.

Powell suggested that the recent rate move was a “mid-cycle adjustment” and “not the beginning of a long series of rate cuts.”

James Bullard, president and CEO of the Federal Reserve Bank of St. Louis, on Aug. 6 said the trade uncertainty would linger for the “foreseeable future.”

“It is not reasonable for monetary policy to respond to all these threats and counter-threats. If you did that, you get a very volatile monetary policy and you’d be contributing to the volatility,” he said in a presentation to the National Economists Club.

Investors expect another rate cut in September, according to the CME FedWatch tool. Nearly 72 percent of traders expect the Fed to lower the rate by 25 basis points and the remaining 28 percent expect a cut of 50 basis points.

Corporate Profits

The major recent driver of equity performance has been a strong corporate earnings season.

For the second quarter, 76 percent of S&P 500 companies reported earnings better than expected, according to data provider Factset.

Although corporate profits beat expectations, they are turning lower. The average earnings for the S&P 500 companies for the second quarter is down by 1 percent, year-on-year, according to Factset.

“Economy-wide, U.S. corporate profits have been falling,” stated Morgan Stanley analysts in a report dated Aug. 5.

Difficulties have been most acute in smaller businesses, which could be a problem for the U.S. jobs market, they added.

However, Goldman Sachs paints a more positive picture on corporate earnings.

Despite uncertainty around tariffs, “the current 11-year-old economic expansion will continue for some time,” according to an Aug. 2 report by Goldman Sachs.

The Fed’s 25 basis point cut in interest rates, along with another cut expected in September will support the economic expansion and hence, corporate earnings growth, the report stated.

Goldman Sachs predicted the stock market rally would continue but cautioned that the U.S. presidential election posed one of the largest risks to its forecast.

Similarly, Mark Mobius, investment guru and the co-founder of Mobius Capital Partners said the biggest risk facing the stock market would be Trump’s failure to win a second term.

“I think the markets then will go haywire because they’ve been depending on Trump policies to keep on pushing the market up and also higher growth rate in the U.S.,” he told the CNBC on Aug. 1.

According to Mobius, while the prospect of his losing the election is unlikely at the moment, the media’s sentiment against Trump is overwhelming.”

“That’s why I am a little concerned about this,” he said.

Follow Emel on Twitter: @mlakan
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