Donald Trump’s return to tweeting about the US stock market is accidentally astute.
The US president is finally reckoning with an important fact: the stock market is not the economy.
Trump doesn’t appear to accept this, however, or understand how the market works.
Yes, the unemployment rate has continued to fall, as the US adds more jobs each month, and the outlook for economic growth looks robust. Wages are increasing, too. All good news.
In response, US stocks experienced their worst week in two years.
On Feb. 5, the Dow plunged more than 1,000 points—the largest point decline ever during a trading day. The S&P 500, the composite index of 500 large American companies, declined more than 4%.
While no one can be entirely sure what’s going on, many analysts believe rising wages set off the market dive. Higher incomes could prompt the US central bank to raise rates to prevent an over-heated economy. Higher interest rates raise the price of borrowing money, pulling liquidity out of the system. That’s bad for companies looking to grow.
So, in this moment, good news for the economy—rising incomes for the average American worker—has become bad news for markets.
How stock markets work
Stocks are a claim to future company profits. That’s what makes them risky, and differentiates them from safer assets, like bonds. In the past year, since Trump took office, some people seem to have forgotten this.
Trump is among them. He routinely takes credit for what had been a booming market, in turn normalizing its healthy returns of recent months and years.
Then the market suddenly tanked. But this may just be the nature of the markets.
At any given moment, share prices are internalizing large sets of information: company earnings, product rumors, government announcements (and tweets), foreign-policy changes, and much more. A massive selloff can be caused by nothing more than one hedge fund, with plenty of capital, choosing to dump a stock. Was there anything wrong with that company? No, but the fund needed money to invest elsewhere.
In the “old days,” the stock market did rise at times as the economy did—and it does on occasion in the new days too. In the past year, jobs reports that showed falling unemployment gave the market a slight push. But stocks also move in ways that can feel unpredictable and detached from economic reality.
That’s partly why previous presidents have steered clear of taking credit for up markets.
Trump’s tax plan hit markets, too
The promise of a major corporate tax cut fueled markets throughout 2017. Now that it has passed, companies are counting on higher profits. The Republicans’ stimulus plan might end up being bigger than Barack Obama’s—which came during the worst downturn since the Great Depression. Trump’s $1.5-trillion tax cut, along with a possible increase of billions in federal spending, may very well supercharge the economy.
But right now it’s also stoking fears of higher inflation and resulting interest-rate hikes.
The Trump Administration claims the tax cuts won’t fuel inflation. Still, Kevin Hassett, chair of the president’s Council of Economic Advisors, acknowledges “it’s clear that the data are so strong that the markets are beginning to worry about Fed policy” and rising rates.
Why wages rise
Wage growth, initially, is not great for firms. It increases costs and can contribute to inflation. Yet wages rise for a whole host of reasons, many of which are good news for firms.
There are two sides to inflation—the kind fueled by rising consumer demand, and the kind brought on by higher wages. The two feed into each other, since growing paychecks fuel spending, which in turn create pricier products that induce workers to demand higher pay.
Wages rise when firms grow because they demand more workers. As the pool of unemployed workers shrinks, each has slightly more bargaining power, and therefore, can demand a higher wage. (In practice, as new workers demand more money, current workers usually ask for more, too, raising wages across the board.)
There’s a reason policymakers and economists wait eagerly for signs of strengthening wages. It’s obviously good news for the average American.
But it also reveals good things were happening for companies, along the way. Relative to this time last year, the markets are still significantly up. That, at least in part, is because of the kinds of things that strengthened wages to begin with: growing consumer demand, surging earnings, and large profits.