Monday was the worst day for stocks in almost two months, with the major indices down nearly a percentage point, following yet another bad monthly report on U.S. manufacturing activity. Still, if you zoom out a little, the picture looks very good. After the drop, the S&P 500 Index remains up
24 percent since the start of the year. Markets are a little worried about manufacturing and about signals the trade war might be intensifying, but they’re not that worried.
We’re a long way from where we were last December, when the S&P 500 lost over 15 percent between the start of the month and Christmas. (That’s one reason stocks are up so much this year: They rebounded from a terrible performance in the last month of last year.) At the time, I wrote about what was worrying investors, and I’ve followed up every so often on the waxing and waning of recession fears.
There has been more waning than waxing, and for good reason: Economic indicators that looked scary a year ago just don’t look as scary now. Let’s take a look at what we were worried about a year ago and why we’re less worried about it now.
One factor that sometimes worries the markets is economically relevant political dysfunction. “Economically relevant” is an important qualifier here: By any normal measure, Washington is dysfunctional, but many aspects of the Trump circus are unimportant for the consumption and investment decisions that drive economic output. I wrote a couple months back that the main reason investors might care about impeachment is a second-order concern: An angry Trump might lash out and do economically damaging things, like launch new trade wars. But since then, the trade situation with China has sat, on average, at a standstill, with the president failing to produce the “Phase One” deal he has promised but also not further escalating the dispute. Congress has not yet managed to ratify Trump’s revised NAFTA in the midst of impeachment, but he has not reacted rashly by, for example, withdrawing from the existing agreement. A repeat of last winter’s economically relevant disfunction — a government shutdown that lasted more than a month — looks unlikely. Overall, these political risks are lower than they were a year ago.
Another thing the markets care a lot about is monetary policy. Last December, an important disconnect emerged between market participants and the Federal Reserve. Investors were afraid the Fed was not taking recession risks seriously and that, even if an economic downturn started to materialize, the Fed might be unwilling to respond appropriately with interest-rate cuts. This seems to have been mostly a miscommunication, and in the last year, Fed chairman Jay Powell has endeavored to get on the same page with the markets, making clear first that the Fed would stop hiking rates and then that it would undertake a “mid-cycle adjustment” of rate cuts in response to worrying economic factors, especially the trade war. Even though the rate cuts have stopped, markets have heard the Fed’s communication and have less reason to worry the Fed will be stubbornly tight in the next downturn. Indeed, the Fed is even talking about beefing up its inflation target in a way that would communicate a stronger commitment to easy money when it’s needed to fight economic weakness. So the Fed is also much less of a source of worry than it was a year ago.
Not everything is great. Worries about economic growth in other regions of the world remain in place. And there are signs that the president’s tariffs — even though he has not escalated them as much as one might have feared a year ago — are harming U.S. manufacturing output.
Still, it’s not clear how big the harm is. The ISM Purchasing Managers Index says the U.S. manufacturing sector has been contracting for four months, but the competing IHS Markit PMI, which surveys a broader range of small and mid-size companies, says manufacturing output is growing. And a big worry from a year ago — that manufacturing troubles would be contagious into the service sector, which makes up the vast majority of the economy — has not materialized. Job-growth and wage-growth numbers also continue to look good, if not great.
I am on the record that this is not the most important focus, but I do know that one thing that interests a lot of people about economic performance is what it means for politics: Is the economy going to help Trump or hurt him? So I will note that in addition to everything I wrote above, Trump has one big reason to feel better about the economy today than he did a year ago: The clock. Every day that we haven’t entered an economic downturn is one less day that he faces the risk we will do so before he faces reelection.
Trump is so unpopular he may well lose even in an economy that would help most presidents cruise to reelection. But it does look increasingly likely to be an asset to him rather than a liability when voters decide whether to keep him for four more years.