Musings to start the week

If you didn’t get to last week’s update, you can find it here.  Needless to say, it was a volatile week!

We have some important economic data this week (March CPI), along with the start of the S&P 500 earnings season for the first quarter.   However, I am not sure that any of this will matter given the meltdown we are currently experiencing, with risk appetite completely frozen, consumer confidence fading and businesses unable to make investment decisions due to policy and economic uncertainty. 

It is not easy to predict the direction of financial markets, because sentiment plays such an important role.  I feel more confident when I look at the economy, and in this respect, the direction of travel of the US and global economies is unequivocally down.  Who could have thought that a leader of any country, much less the leader of the largest and greatest country in the world, could wreck an economy so quickly?  On that merry note, below are a few thoughts to start the week.

Tariffs and balance of trade

I have written about the US balance of trade and tariffs, and you can read that article to learn more about Mr Trump’s obsession – the US balance of trade deficit.  

Trade deficits are caused by a number of factors, many that have nothing to do with tariffs.  In fact, one of the main reasons the US has a large trade deficit is because Americans prefer to spend rather than save.  As you can see in the table to the left, consumption is a much more important driver of economic growth in the US than in many other countries.

As the table shows, the US has one of the highest consumption rates of the G20 countries.  Of course, the ability of Americans to spend like drunken sailors is also related to its economic power.  Americans have the largest and most diverse economy in the world.  US GDP in 2024 was $29.2 trillion (circa 27% of global GDP), with the next largest economy – China – having GDP in 2024 of $18.3 trillion (with three times the population).  The US, the world’s third largest country by population, is also one of the wealthiest. 

Naturally, the corollary to spending (consumption) is savings.  The table to the left ranks several countries by their savings rate as a percent of GDP, showing that the US – not surprisingly – has a very low savings rate.

This consumer behaviour is a key driver of the US economy and a major factor that contributes to the US running a trade deficit.  Factors driving the trade deficit aside from tariffs, including consumer behaviour, seem to be completely ignored by the Trump economic team. 

The elephant in the room

The fact that Mr Trump is blowing up markets with his tariff policy in order to narrow the trade deficit takes the eye off the elephant in the room – the US budget deficit.  Government debt has increased under every president (including Trump 1.0) since Bill Clinton last oversaw a budget surplus in the late 1990s.  Currently, US debt is approaching $36.7 trillion, and the country is on target to have a $2 trillion deficit in the 2024-25 tax year (source is US debtclock).  The deterioration in the US financial situation can be laid at the feet of past presidents and Congresses across both parties, as neither Republicans nor Democrats seem to be able to balance the books.  And rest assured, reducing the budget deficit will be painful for the US economy, because it will involve raising taxes or reducing government expenditures, both of which would be analogous to putting on fiscal brakes.  The rapidly deteriorating state of the US federal budget concerns me much more than the trade deficit, because the US has paid nothing yet for its fiscal mismanagement.  My fear is that when investors start to recognise the deteriorating state of US finances and develop alternatives to the US Dollar and US Treasuries, the adjustment will be severe and rapid, and most certainly deserved.  

As an aside, US debt has already breached the debt ceiling (of $36.1 trillion), so the Treasury can only refinance existing debt and rely on “extraordinary measures” to fund the government.  These extraordinary measures will likely run out in the summer, unless a 2025-26 budget is agreed before then. This could cause yet another debt ceiling discussion before a new budget is approved, something that always rattles markets.

The Fed and its role

There are plenty of suggestions in the press and from investors, mainly from supporters of the tariff policy invoked by the current administration, for the Federal Reserve to reduce interest rates, invoke another round of QE, or adopt other monetary easing policies quickly. De facto, investors pushing for the Fed to ease are simply asking for a "Fed put" to (hopefully) floor risk asset prices, especially stocks. Keep in mind that It is not the Fed’s job to bail out stock investors or to offset errant fiscal policy. Rather, it’s the Fed’s job to keep inflation in check and to maintain a solid jobs market. These are the central bank’s two mandates. In addition, as it has done in the past, the Fed can provide emergency liquidity to markets if they seize up, and especially to ensure that the intrabank market remains liquid and orderly. That’s the Fed’s role, and I am so grateful they are independent from the executive branch, especially this one!

Deteriorating financial markets

Some investors saw this train wreck coming and lightened on risk, but most investors did not simply because the tariffs announced on “Liberation Day” were much broader and severe  than expected.  Furthermore, fear has now crept into investor mentality, exacerbating the sell-off.   The fact is that US stocks were too expensive anyway when compared to historical valuation metrics, so the sell-off that was experienced in the first quarter – which was orderly – was arguably overdue.  Trying to time the market is impossible, but you will need to assess your own risk appetite and ensure that you are comfortable sitting through periods of softness and high volatility.   I’ve seen this movie many times before, and it never feels good to experience the unrealised losses and uncertainty.  Please try to remember that stocks offer excellent returns over many years and need to be a cornerstone of any investment portfolio.  However, portfolios need to be diversified and comprised of other asset classes to allow you to sleep at night.  And believe me, even with a portfolio mix that you are pleased with does not guarantee you will sleep well when we are going through the turmoil we are currently experiencing.  So hang in there.

WHAT’S AHEAD

Economic data that matters this coming week includes US CPI and PPI for March, and an update on US consumer sentiment.  The minutes will also be released from the last FOMC meeting.  China releases its CPI for March, and the Eurozone will release February retail sales. 

Earnings for S&P 500 companies also begin this week, starting with Delta on Wednesday – which should provide a harbinger of consumer spending for travel – and the banks on Friday, including JP Morgan, Wells Fargo and Morgan Stanley.

Upcoming central bank policy meetings are as follows:

• ECB: April 16-17

• Bank of Japan: April 30-May 1

• FOMC: May 6-7

• Bank of England: May 8