You know what's in short supply right now? Context. I feel we are very short on context and investors are making rash decisions based on minutiae and current events, not the bigger picture. Fortunately, we are having a breather. Some good earnings, no destructive talk out of Washington, at least not yet, and a benign set of conference calls and we get to catch our collective breaths and I get to explain what the heck happened here.
Ever since this dastardly month began we have seen incredible headwinds from Washington that have smothered tailwinds from Wall Street and, now, after these last two weeks, Main Street. It's almost as if Washington has coalesced to stop the economy in its tracks with the Fed worried about an economy that's too hot and President Trump cheering a hot economy.
I get that. A president always wants an economy that is growing. A Fed always has a dual Goldilocks mandate, which includes trying to get an economy to hire as many people as possible and build as many buildings and homes and product as possible, but not too many or there will be inflation.
Both are worthy goals. The president, though, doesn't get that every time he says the economy is red hot, his handpicked Fed chief, Jerome Powell, feels the need to tighten rates, move them higher, even as we have now had eight rate increases from the bottom in 2016. It's worse, if you took the president seriously, you would think that we need four rate hikes in lock step, something that Powell rather foolishly said instead of saying you know what, we will raise a ninth time and then we have to give it a break to see if we can declare victory against inflation.
Now let's put this all in context. The first part of this selloff, I think, was about the notion that Wall Street is too bullish on the current earnings prospects for companies, particularly because the Federal Reserve has laid out plans that will cool the economy so fast that 2019, domestically, could be a down year over 2018. In other words, numbers are too high because the Fed has mandated that the economy go from being too hot to perhaps too cold, just to be sure inflation doesn't roar.
The second part of the selloff has to do with the president's newfound containment policy toward China where he doesn't want to negotiate as much as he seems to want to overthrow. I think we have gone well past the Art of the Deal by Donald Trump and now we are going by the Art of War playbook by Sun Tzu.
The problem, of course is that tariffs are an odd way to conduct war. I get it. We hit them in the pocketbook and they give in. Makes sense. But they aren't giving in easily and as they get more intransigent we discover what happens to our businesses that are deeply involved with China in one way or another. Maybe one of our companies wants to merge with another company, like United Technologies (UTX) wants to buy Rockwell Collins (COL) and then split into three companies to bring out value. The deal gets held up by Chinese authorities. Now we know that United Technologies is a huge employer in China, indispensable to the Chinese aircraft business. It is rational that the Chinese approve the deal. But they may not and United Technologies pulls out of China. That's extreme but boy would that hurt numbers. Apple (AAPL) gets boycotted, again extreme, cut numbers. Companies that make things there to bring here, numbers get cut.
It's gotten to the point that if you are on these conference calls all you hear is "how are the tariffs hurting you."
Now the president refuses to acknowledge that these tariffs are hurting Main Street. He's got a bigger imperative. He's treating the Chinese like the Soviet Union. He wants to be Reagan, he wants that wall torn down. This time, though, it's the Chinese wall and the PRC is not some decrepit easily rolled nation.
The Fed chair refuses to acknowledge the damage the tariffs are starting to do, either. I know if the president wanted his way with the Fed, at this point he would have to use reverse psychology and demand enough tightenings to throw us into recession. Jay Powell has to go out and say "you know I wanted to tighten once in December, our ninth tightening, and then three more next year, but the president is so bent on destroying the economy to bring down the PRC that he is doing my work for me and I can sit back and watch the damage occur. What a great tour de force way to get control of the situation. I hope he does it.
But now, I want to go back to the context here. There's a big straw man I keep hearing, the straw man is that the economy is so strong that, not to worry, Powell can tighten all he wants, even go beyond this mythical figure and we won't have a recession.
I find that logic appalling. We are not talking about having a recession. We are talking about reversing a lot of the great growth we have had and creating rounds and rounds of layoffs because of a lack of demand in autos, in housing, in construction and so many other industries. That's really what's in the cards.
You know what's not in the cards? Another Great Recession. We can have lots of economic activity cease, we can have businesses no longer want to grow, we can have a cessation of cross border trade and what would happen is that Main Street would do badly. But as long as the corporate and individual balance sheets are strong -- and they are -- we are not going to spiral into some sort of systemic risk situation.
Yet, on Wedneday it was obvious that many felt that we were going to go into something more severe. There were enough issues and disappointments on the table that it is easy to see how we could get into some real ugliness that hurts corporate profits and slashes earnings per share. But that and the attendant layoffs are the prices we are going to have to pay if these gigantic games of chicken between the president and the Fed and the president and china keep hurtling toward the cliff.
Now I am smart enough to know that I don't know who will blink. I am also smart enough to know, though, that someone has to, one of these parties or we will have to repeal these nice gains that come from having Visa (V) and Microsoft (MSFT) and Tesla (TSLA) and Ford (F) among a host of other companies report great numbers.
My point is a simple one: those who want the economy slowed because of inflation, you should be careful what you wish for. You will get all the deflation you need if these games of chicken escalate.
But if you get one thing out of my contextual lesson it's that this is not 2007 where there was too much damage to avoid a crash. This is 2006, when it could still be averted. Let's hope the policy makers recognize that, and we can avoid a painful but not cataclysmic downturn like we had when they knew nothing and that game of chicken ended in disaster.