Two contradictory things can happen at the same time. But maybe not indefinitely.
Investors are contemplating what seem to be contradictory trends in financial markets and wondering how long they can last. President Trump’s tariffs are beginning to cause tremors in the real economy. But the stock market keeps drifting higher, as if boom times are nigh. Does it make sense?
Investors must think so, for now, anyway.
Buyers keep buying, with the broad S&P 500 (^GSPC) index hanging out near record highs and the narrower Dow (DOW) index near its first record close since last December. Stocks have been on a tear since Trump backed away from steep tariffs in early April and instead pursued a more modest country-by-country approach to trade deals.
But all is not well. An Aug. 15 New York Times headline told readers, “The stock market is getting scary.” Economist Burton Malkiel pointed out that stock valuations are near the highest levels in 230 years, warning that “there are worrisome signs that investor optimism may have gotten out of hand.”
It’s not just the mainstream press that’s worried. Money managers at Morgan Stanley, Deutsche Bank, and Evercore are preparing clients for a possible 10% to 15% drop in stock values, according to Bloomberg. Goldman Sachs sees a “latent risk of unwinds” if anything upsets a fragile “Goldilocks” setup. In an Aug. 14 video for clients, Tom Lee, co-founder of investing firm Fundstrat, highlighted the recent jump in wholesale inflation and said, “yet the stock market barely cared.”
What seems to be happening is that the stock market is diverging from the real economy. The signs of an economic slowdown include sharply slowing job growth and a surge in wholesale inflation caused largely by all of Trump’s new taxes on imports. Consumers expect higher producer costs to push up retail costs in the coming months, pushing overall inflation from 2.7% now to around 4.5%. That’s depressing overall consumer sentiment.
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It’s not alarming for the stock market and the economy to go in slightly different directions. As Sam Ro points out in his TKer newsletter, the stock market often functions as a “discounting mechanism” assessing future growth and earnings. And some Wall Street analysts think the early 2025 swoon — with the S&P down 21% from late February to early April — represented stocks pricing in the slowdown we’re undergoing now. If so, the current run-up might be telling us the economy will do better by the end of the year than the meek 1% GDP growth many economists are forecasting.
