I see four main issues, which–now that I’m on semester break–I’m planning to write about over the next few days. They are:
—machines vs. humans. This is the question of increased short-term volatility. How do we cope with the apparently mad dashes in and out of the market by trading robots using, by historical standards, half-baked trading algorithms?
—decelerating earnings growth. EPS growth in 2018 for publicly traded companies was around +20%. Increases for 2019 will likely come in at +8% – +10%. This kind of sharp falloff is normally a bad sign for stock prices. In the current case, however, the 2018 EPS surge is only in after-tax earnings and is due mostly to the one-time decrease in the Federal corporate tax rate from 35% to 21% that went into effect last year. Pre-tax earnings grew at a much more sedate rate of around 10%, I think. While the 2019 situation isn’t wildly positive, it would seem to me to imply a flattish market where the investor’s job is to identify areas of potential strength to buy and areas of potential weakness to avoid.
But is this the way algorithms will operate?
—the business cycle and interest rates. Typically, the Fed raises short-term rates when it perceives the economy is overheating. Higher rates make bonds less attractive. They make other financial instruments, like stocks, less attractive, too. But the negative effect of higher rates is offset by surging earnings growth. Is +10% enough to do the job in 2019?
–tariffs. (A side note first: it seems to me the Trump administration argument that it can usurp Congress’s power to set trade policy because everything economic is a matter of national security is ludicrous. Not a peep from Congress, though. To me, this implies that Mr. Trump is simply the spokesmodel for policies the forces in Congress want enacted but don’t want to be held responsible for.)
Tariffs have, at best, a checkered history. They invite retaliation. They have unforeseen/ unintended negative effects: Apple’s preannouncement of weaker than expected results in its current quarter may only be the first. In addition, the rapid and seemingly arbitrary way tariffs have been enacted in the US has already given both domestic and foreign corporates pause about expanding operations here. One thing is certain, though –tariffs slow economic growth. The question is by how much and for how long.
—the independence of the Federal Reserve. By conventional measures, there’s still too much money sloshing around in the US. So there’s every reason for the Fed to continue to shrink its bloated balance sheet and to slowly raise short-term interest rates (the specter of Japan’s three decades of stagnation–resulting in large measure from saveral bouts of premature policy tightening–continues to be a cautionary tale against moving too quickly). Because of this, Mr. Trump’s musing about firing Jerome Powell has a distinctly Nixonian ring to it, conjuring up echoes of the runaway inflation and currency collapse in the US of the 1970s. From a stock market point of view, threatening the Fed may be the single most damaging thing Mr. Trump has done so far.
More details over the next few days.