Downfall In The Dow
It’s fair to say that Wall Street did not anticipate China’s retaliation to U.S. tariffs. Last week, the negative reaction to President Donald Trump’s announcement of new tariffs on China was oddly muted. On Monday, after China’s response was announced just before the market opened, the S&P 500 fell by more than it had done in the entire previous week.
It looks as though both the United States and China have underestimated the strength of the other’s position and willingness to escalate. Meanwhile Wall Street, which spent the time since the Buenos Aires “truce” in November busily working on the assumption that a deal was a given, has totally misjudged both sides. Why has China done this? I suggest that it is all down to the Dow Jones Industrial Average. Here goes one version of perception from China:
Trump measures himself by the Dow Jones Industrial Average. There is no reason to doubt this. Record markets have been taken as a presidential validation ever since the benchmark topped 20,000 in Trump’s first week in office. But there are three problems with this notion:
First, the odds are stacked against Trump from the start. He began with stocks already fully valued, and with interest rates low and bound to rise. These factors are far more important to the stock market than anything a president can do in office. Presidents who entered when stocks were cheap tended to oversee strong markets. By this measure, the most successful presidents in history were Bill Clinton and Barack Obama. Meanwhile, the S&P 500’s valuation when Trump took office at the start of 2017 was almost identical to its valuation when Herbert Hoover took office in 1929: 28 times cyclically adjusted earnings, according to Yale University economist Robert Shiller. It has since risen further, which is an impressive testament to investors’ optimism under Trump’s leadership, but further headway will inevitably be more difficult if the market starts from a more expensive position.
Second, at least two other organizations have more power over markets than the White House. They are the U.S. Federal Reserve and the Chinese Communist Party. Trump does not directly control either of them. The Fed’s volte-face on planned interest rate increases for this year helped to spur the recovery in stocks, and a series of ever more insistent presidential tweets makes it clear that Trump would prefer the central bank cut rates, not just keep from raising them.
Moves in China’s domestic economy have an outsized effect on stocks in the developed world. To demonstrate this, look at how the 100 stocks in the MSCI World Index of developed-market stocks with the greatest exposure to China have performed compared to the MSCI World Index as a whole:
When China is slowing down, as it did last year or in 2015, world markets sell off. Once it starts to stimulate, as in 2016 or in the first few months of this year, developed-market stocks start to roll.
Third, a higher stock market is not what the people who voted for Trump wanted. Indeed, it may even run counter to it. After years of intensifying inequality, higher share prices would tend to exacerbate inequality. Higher wages and more jobs, which is what the Trump electorate needs, tend to cut into profit margins and reduce share prices while raising interest rates. And big American companies derive a huge chunk of their income from overseas. Bolstering the stock market is not consistent with an “America First” policy.