Trillion Dollar Deficits

There can be little doubt that the US economy is strong right now. What’s harder to work out is whether stock prices have factored this in, or whether the bull market has more left in the tank.

The popular narrative doing the rounds right now is that the current bull market (if measured from March 2009) is one of the longest in history. It will take that mantle if it’s still going by late August.

The bears say that’s reason to believe this cyclical expansion is coming to an end. And the weight of probability suggests that is the correct view. But who’s to say this bull market can’t continue for another six or 12 months?

After all, it’s not the biggest bull market in terms of percentage gains. That honour goes to the infamous 1920s bull run, which delivered gains of nearly 500% over a period of 96 months.
The current bull market, in contrast, is up ‘only’ around 300% over 113 months.

Bull Market Close to it’s Death Bed?

Given the impossibility of predicting the future, I’ll run with the probability angle and say the bull market is getting close to its death bed. But I’ll concede that the body is still in good health.

For example, after the US market closed, Google’s parent Alphabet posted a strong quarterly result, which saw the stock price jump in after-hours trade. More tech earnings are on their way, so the next week or so will tell us a lot of about the strength or otherwise of this tech-led bull market.

And then there’s the Trump factor to consider. On the one hand, his tax cuts provided a big boost to the ageing bull in late 2017 and early 2018. But on the other hand they were financed by debt, which makes the US fiscal situation look pretty dire. Then there’s his twisted trade logic, driven by adviser Peter Navarro.

First, let’s look at the other side of the tax cuts…rising US government debt. In the year to 30 September, the US government’s deficit will come in at US$890 billion. That’s a long way from the initial deficit projection of US$440 billion, made in March last year.

At the same time, the deficit forecast for the 2019 fiscal year was ‘just’ US$526 billion. Now it’s projected to hit nearly US$1.1 trillion, and remain at US$1 trillion-plus for the next two fiscal years thereafter. A reduction in government spending is not offsetting the reduction in receipts from the tax cuts, leading to a blow out in deficit spending.

And this is occurring at a time when the US economy is very strong. Moreover the assumptions underpinning the budget assume the US economy gets even stronger in 2019, before falling back to a long run forecast of 2.8%. 

What’s going to happen if the Fed hikes too much and pushes the US economy into recession in 2019 or 2020? What will the deficit look like then?

‘Much bigger’, is the answer.

How will the US finance the deficit?

And how will the US finance the deficit? For one thing, it needs China to keep reinvesting its trade surplus into US treasuries.

Trump might complain about the trade deficit the US has with China, but much of that deficit comes right back to finance the US government’s deficit spending.

How? Well, under a free and floating currency exchange system, a country with a chronic trade deficit (meaning an outflow of currency to pay for goods) should experience a weaker currency. The idea is that this removes purchasing power and will reduce the deficit.

At the same time, the trade surplus country (China) should experience a stronger currency. This increases purchasing power and encourages consumption, thus reducing the surplus.

But put very simply, China doesn’t want its currency to appreciate so it prints yuan to offset the inflow of US dollars. But here’s the thing, it then sends the US dollars back to the US by buying US treasury bonds. It must do this in order to prevent its currency from appreciating. In this way China’s currency manipulation benefits the US by helping to finance US government spending.

But now Trump wants to reduce the trade deficit with China. And he wants to do so by imposing tariffs. So he’s taxing consumption and potentially reducing a source of financing for the government at the same time.

There are too many variables to predict how this might play out. But the textbooks would say the result will be lower growth AND higher interest rates. That’s not a good combo when US share prices are very close to all-time highs.

Regards,

Greg Canavan,
Editor, Crisis & Opportunity


Greg Canavan is a Feature Editor at Money Morning and Head of Research at Port Phillip Publishing. He likes to promote a seemingly weird investment philosophy based on the old adage that ‘ignorance is bliss’. That is, investing in the Information Age means you have all the information you need at your fingertips. But how useful is this information? Much of it is noise and serves to confuse, rather than inform, investors. And, through the process of confirmation bias, you tend to read what you already agree with. As a result, you often only think you know that you know what is going on. But, the fact is, you really don’t know. No one does. The world is far too complex to understand. When you accept this, your newfound ignorance becomes a formidable investment weapon. That’s because you’re not a slave to your emotions and biases. Greg puts this philosophy into action as the Editor of Crisis & Opportunity. As the name suggests, Greg sees opportunity in a crisis. To find the opportunities, he uses a process called the ‘Fusion Method’, which combines traditional valuation techniques with charting analysis. Read correctly, a chart contains all the information you need. It contains no opinions or emotion. Combine that with traditional stock analysis and you have a robust stock-selection strategy. With Greg’s help, you can implement a long-term wealth-building strategy into your financial planning, be better prepared for the financial challenges ahead, and stop making the basic, costly mistakes that most private investors do every time they buy a stock. To find out more about Greg’s investing style and his financial worldview, take out a free subscription to Money Morning here. And to discover more about Greg’s ‘ignorance is bliss’ investment strategy and the Fusion Method of investing, take out a 30-day trial to his value investing service Crisis & Opportunity here. Official websites and financial e-letters Greg writes for:


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