Wall Street analysts are now predicting that the S&P 500 will report earnings growth of 11.33% in 2024 and 14.4% in 2025. While these are estimates, the outlook is very strong, and has even been revised up since the end of last year. We are in the midst of a “soft landing” with expectations of rate cuts ahead by the Fed, which is a bullish scenario.
Inflation has come down to 3%, and while prices are still 21% higher than when the pandemic began in early 2020, the inflation swap market is previewing 2% inflation in one year’s time. Low unemployment and real wage gains are keeping the consumer positive, and stimulative fiscal policy is still providing a tailwind to the economy.
Political winds may begin impacting the stock and bond markets as we approach the end of the year, but this summer should remain relatively benign. Expectations so far this year called for central bank policy rates to remain elevated in the first half, before receding in the second half. This is still the case, with a few caveats. The root cause of inflation was due to supply and demand imbalances caused by Covid, increasing commodity prices, and very stimulative fiscal policy. What is new is the increasing likelihood of a Republican victory in the US Presidential elections. Trump has proposed a 10% universal tariff on all imports, and a 60% tariff on all imports from China.
Tariffs are inflationary. They raise prices and reduce economic growth. According to The Tax Foundation, a D.C. based economic think tank, imported goods amounted to $3.1 trillion last year, and imports from China totaled $421 billion. The Trump tariff proposals would raise the US government’s income by some $500 billion, but will shrink US GDP by 0.8% and cost an estimated 684,000 jobs. Sixteen Nobel Prize winning economists have warned in a recent letter that the Trump economic plan will re-ignite inflation. Several non-partisan research groups, like the Peterson Institute, Oxford Economics, and Allianz corroborate that. Some Wall Street analysts believe that China’s growth would be cut in half from its current level of 4.7%.
Trump would also like to extend his 2017 tax cuts, which the Congressional Budget Office warns will cost the government $5 trillion. He also indicated recently in a closed-door meeting with CEO’s that he would like to cut corporate taxes further. Economists are also concerned that that the Trump plan to deport all illegal immigrants will cause labor market tightness, increase wage pressure, and result in higher consumer prices.
These factors are of course dependent upon the outcome of the election, but may constrain the Fed from cutting rates in the near term until that outcome is known. The current Fed Funds rate after all, isn’t far from its historical average (since 1971) of 5.42%, and could be considered at a “neutral” level now, neither too high to choke off economic growth, nor too low to spur inflation.
The second half of 2024 is likely to bring focus to the U.S. bond market. Fed Chairman Jerome Powell expressed earlier this year that the national debt is a long-term threat to the economy, and on an “unsustainable path.” The current level of Federal debt stands at $35 trillion, and the government itself projects that debt to be above $54 trillion in 2034. That will approach 200% of GDP.
Government issuance of bonds is probably the biggest risk to markets today, especially since the Federal government is running a record deficit during an expanding economy of 6.7%. With a record $8.9 trillion of US treasuries coming due this year, there will be over $10 trillion of government bonds issued in 2024. Someone needs to buy them. This amounts to more than one-third of all government debt outstanding, and more than one-third of US GDP. Meanwhile, foreign ownership of US treasuries in in a declining trend, and continues to decline.
If the supply of bonds is not met with enough demand, bond prices go down and bond yields rise, making credit more expensive, which is contractionary. All of this is occurring while the Federal Reserve is selling $60 billion per month to reduce its very own holdings of treasury bonds,
Will the largest buyers of treasury bonds continue to buy if interest rates go down? This remains to be seen, but the sheer scale of issuance points in the direction of higher bond yields, which usually favors banks, insurance companies, and brokerage firms.
The selection of J.D. Vance as Trump’s running mate is curious considering that he opposes free market policies. He is openly enthusiastic about devaluing the dollar, which is inflationary because the dollar price of foreign goods increases relative to domestically produced goods, and the U.S. imports a lot ($3.1 trillion).
The S&P 500 index was up 14.2% in the first half of the year, the Dow up 2.5%, and the Nasdaq up 18.1%.
Grant Rogers
