Investors Fear the Tax Cuts Will Work Too Well

Losses shown on a television screen above the floor of the New York Stock Exchange shortly after the closing bell on Monday.

“The stock market has smashed one record after another, gaining $8 trillion in value. That is great news for Americans’ 401(k), retirement, pension and college savings accounts.”

That was President Trump only a week ago during his State of the Union address as he triumphantly touted the gains in the stock market since he became president.

And then, well, you know. Stocks plunged Friday, and on Monday the market continued to plummet. The Dow fell almost 1,600 points at one point before finishing down more than 1,100 points, or 4.6 percent.

Fingers, of course, are pointing.

The president’s critics have said his decision to tether his success or failure to the stock market was ludicrous.

Yes, it was a mistake, but not for the reason you might think.

The reason for the market’s downward turn isn’t that investors believe his stimulus measures, like tax cuts and deregulation, are failing, or might fail.

It is quite the opposite: Investors believe his policies to stoke growth are going to work so well that they will overheat the economy, and force the Federal Reserve to try to slow things down by raising interest rates faster than expected.

Sometimes you can have too much of a good thing. Don’t forget what set off the plunge on Friday: better-than-expected job growth numbers.

It is very possible that by the time election season comes around for 2020, even if this market dip is simply a blip, the economy will be, or will have been, in a recession.

To explain the phenomenon, Ray Dalio, the founder of the largest hedge fund in the world, Bridgewater Associates, imagined the president at the wheel of car.

“Fiscal stimulation is hitting the gas, which is driving the economy forward into the capacity constraints,” Mr. Dalio said. That, he added, “is triggering interest rate increases that are hitting the brakes, first in the markets and later in the economy.”

Before all the pundits pass out from hyperventilating over the market “correction” — and quick fact-check: technically a correction is defined as a drop of 10 percent or more — let’s take a deep breath: The market’s fall may seem precipitous, but it has dipped only 8.5 percent from the top.

That’s certainly significant, especially if you jumped into the market in the last several weeks for the first time. But, in truth, it’s as if we had turned back the clock to where the stock market was in the middle of December, when investors — and, yes, the president — were proudly cheering its success.

The market was always bound to turn downward after a record run. Early last week, Peter Oppenheimer, chief global equity strategist at Goldman Sachs, predicted as much, saying, “Whatever the trigger, a correction of some kind seems a high probability in the coming months.” He probably didn’t appreciate how quickly he would be proved right.

Despite a steady drumbeat of optimism about the economy from top business executives — and rightly so, given the record results they’ve been producing and expect to produce over the next year — some investors have been quietly suggesting that the market was starting to look expensive when factoring in the likelihood of inflation.

“With the global economy rebounding and resource utilization tightening, we are carefully positioning for the possibility that inflation surprises to the upside,” Ken Griffin, a co-founder of the Chicago hedge fund Citadel, wrote in a note to his investors last week.

At the World Economic Forum last month in Davos, Switzerland, chief executives were remarkably optimistic about their own businesses and the economy. But Jamie Dimon, chairman and chief executive of JPMorgan Chase, added a note of caution: Things were going so well, he said, that “I promise you, we are going to be sitting here in a year and you all will be worrying about inflation and wages going up too high.”

That optimism may be an economic contra-indicator. “Optimism about global growth is disturbingly high at Davos,” Scott Minerd, the chief investment officer of Guggenheim Partners, told Reuters. “While I am of the opinion that the global economy is gaining momentum, I always find it discomforting when virtually everybody shares the same opinion. My fear is that that economic optimism is spilling over into global equities, which will lead to a mania in stocks.”

For now, that fever may be breaking, but it is likely to be only temporary. “These big declines are just minor corrections in the scope of things, there is a lot of cash on the side to buy on the break, and what comes next will be most important,” Mr. Dalio wrote in a note to his clients Monday.

How long this bull run will continue is anyone’s guess, but the betting line is that while it may have another a year or two, it will end.

“History shows that economic cycles exhibit fairly consistent symptoms leading up to a recession,” Guggenheim wrote in a note to investors late last year, “starting with a labor market that evolves from cool to hot and a monetary policy stance that progresses from loose to tight in response.”

“Our analysis of these metrics suggests that the current expansion will end as soon as late 2019,” Guggenheim wrote.

Just in time for the next presidential election.

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