The US economy? It’s complicated…
Much has been made of the harm that may come from current White House economic policies. Risks from tariffs, the expanded deficit, inflationary pressures, high interest rates, antagonism toward the Fed Chair, etc. receive significant coverage, as well they should. Indeed, these fears may be well-placed. Recent volatility in bond markets may be signaling heightened potential for inflation and economic downturn.
At the same time, many economic indicators show cause for continued optimism. The numbers look strong – perhaps nuanced with evidence of slowing but strong overall. Stock markets are near all-time highs, corporate earnings and guidance have come in broadly positive, employment seems stable, and consumer spending remains durable.
Citizens watching the country swirl about them likely feel bewilderment at the pace of change and transformation. How should investors react to this stage of our economic history? With ample evidence for both concern and optimism, should investors believe the fearful left or the emboldened right?
I think we are in a phase where elements of both viewpoints can be true: current policies could well lead to slowdown even stagflation; and many sectors within the economy and markets may continue to prove their depth and resilience. This is why it’s so hard to get a clear read on where this all might lead: it’s time to take a step back and consider.
Ecosystem.
In prior writings I’ve described the economy as a massive ecosystem like a bayou or ocean that is dynamic, active, dispassionate, and impersonal. It is made up of millions of different sectors, businesses, families, and individuals, each trying to find their way to survive and thrive. Some rise, some decline, new firms are created, others struggle, some perish. Overall, the system has shown remarkable flexibility and durability over the years despite the challenges it has faced.
This is a helpful model to bear in mind. I suspect individual investors underestimate the size of the system. Also, many seem to view the system as fragile and linear, assuming that one problem leads to the next and to the next, until the whole thing collapses. I disagree. The system is varied and dynamic. When a tree falls into a bayou, it might devastate whatever is underneath it, but the overall bayou evolves and moves on. Note that this evolution takes time and with myriad competing factors, it can be near impossible to isolate specific cause and effect.
Tariffs.
This ecosystem metaphor can help us understand the impact of tariff policy. A common (and reasonable) conclusion has been that tariff policies will be inflationary. The on again/off again nature by which tariffs are being announced undermines the confidence of multinational firms and worried investors. And yet inflation has not shown up significantly in figures such as the CPI or PCE. Why?
Limited scope. Tariff impact may be watered down a great deal before it reaches end consumers. Some 70% of the US economy is services: not directly impacted by tariffs. Of the remaining 30%, producers source inputs from a variety of locations domestic and foreign, with various trade agreements in place.
Distributed. As potential tariffs work through global trade networks, the impact may be distributed across different actors throughout the chain and not all passed along to end consumers. Since the pandemic shutdown, we’ve learned that the global supply chain network was not all that optimized and there was/is slack and room for reconfiguration.
Positive impacts. Tariffs may lead to increased government revenues. The demand for trade may be such that the increase in tariffs doesn’t substantially depress activity. Finally, it is likely that trade negotiations may lead to greater equity with US trading partners. This has long been a point of contention for US exporters: unfair practices imposed by foreign trade partners. Low levels of tariff reform may lead to positive outcomes – not a point being broadly made in the national dialog.
The US consumer. In the end, it may come once again down to the persistence of the US consumer. Confusion and uncertainty may be what is driving low consumer sentiment numbers, but spending remains strong. Consumers feel bad about the economy though this hasn’t largely influenced their (our) willingness to spend.
How will this all play out?
Only time will tell where this all will lead. In the end, we are likely to see continued volatility but my guess is that we also see continued resilience, meaning that investors who are patient, well-diversified, and calm are likely to be rewarded. Diversification allows investors to follow different themes that play out over years and decades (themes such as changing demographics, the impact of AI, re-globalization, climate change, etc.). If the market goes up, down, or sideways, investors should have tools in place to seek growth while managing risk so that they can continue to follow long-term game plan and not be distracted by headlines.
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This material is for general information only and is not intended to provide specific advice or recommendations for any individual. There is no assurance that the views or strategies discussed are suitable for all investors or will yield positive outcomes. Investing involves risks including possible loss of principal. There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk. The economic forecasts set forth in this material may not develop as predicted and there can be no guarantee that strategies promoted will be successful.
The Consumer Price Indexes (CPI) program produces monthly data on changes in the prices paid by urban consumers for a representative basket of goods and services (Source: U.S. Department of Labor).
The PCE price index, or Personal Consumption Expenditures price index, is a measure of the prices of goods and services purchased by people in the United States.