February 14, 2018
Albert Edwards, the top-ranked strategist at Societe Generale, said President Trump’s tax reform will bring an end to the U.S. economic expansion, topple the stock market and result in a massive budget deficit.
“This fiscal expansion is probably the most foolhardy escapade in modern economic policy history,” Edwards said in a Feb. 14 report. “To say it is ill-timed and ill-judged would be a massive understatement.”
Trump ran on a pro-business platform intended to help U.S. workers by cutting taxes and regulation, shrinking the trade deficit with countries like China and Mexico and spending $1 trillion on infrastructure projects like roads, bridges and airports. In December, he approved a sweeping tax reform bill that cut corporate tax rates and gave multinational companies an incentive to return billions of dollars in offshore cash to the U.S.
The tax cuts helped to lift U.S. stocks as investors expected companies to report higher profits, dividend payments and stock buybacks. But this month’s stock market decline of more than 10 percent from a recent peak signaled that investors were starting to worry — possibly about inflation pressures or a two-year budget deal that shows a deficit of more than $1 trillion for 2019.
“Even before Congress passed the expansive two-year debt-limit budget agreement last week, bond markets were belatedly recognizing the irresponsibility of the fiscal package,” Edwards said. “The surprise surge in wage inflation in the payroll report may have been the match that lighted the equity market turmoil, but it was the irresponsible fiscal stimulus that provided the kindling.”
Not everyone agrees with Edwards, who established his reputation as a perma-bear in 1996 with his Ice Age thesis that argued that stocks will collapse and bond values will climb because of deflation.
David Rosenberg, the chief strategist and economist at Gluskin Sheff & Associates Inc., said the decline in stocks last week was caused by a lack of liquidity more than signs of higher inflation. Liquidity describes how easily assets can be bought and sold at stable market prices.
“This isn’t about inflation. If it were, TIPS break-evens would be sitting far higher than 205 basis points,” Rosenberg said in a Feb. 12 report, referring to Treasury inflation-protection securities. “Oil wouldn’t have collapsed 10 percent last week.”
Edwards is looking for signs that workers will demand more pay, particularly after the Feb. 2 employment report that showed wages grew 2.9 percent from a year earlier. He said a survey by the National Federation of Independent Business showed a sharp jump in the portion of small businesses that planned to raise wages. Finding quality workers was the No. 1 worry for companies, ahead of other concerns like taxes and regulation.
“The genie is now out of the bottle and the markets will react very badly to any sign of inflation,” Edwards said. “Investors are beginning to become concerned that the wage inflation dog that had not barked over the last couple of years can now be heard and that the huge fiscal stimulus will only exacerbate developments.”
Edwards is keeping an eye on the yield of the 10-year Treasury note for signs that investors are concerned about inflation. A rise above 3 percent would be a key breakout level, according to Societe Generale’s technical analysis team.
Edwards also is monitoring the value of the Japanese yen in relation to the dollar. The U.S. currency has lost 10 percent of its value compared with the yen since the beginning of 2017.
“The yen, which no one is focusing on, makes me more nervous,” Edwards said. “If the dollar decisively breaks below the 107.9 yen/dollar support and yen shorts rapidly unwind, commentators will no doubt attribute this to the inflationary consequences of the Trump fiscal stimulus.” The yen traded at about 106.98 to the dollar on Wednesday afternoon.
If stocks collapse as they did after the dot-com bubble of the 1990s and the subprime housing bubble that peaked in 2006, an ensuing recession will trigger a bigger federal deficit, Edwards said.
“The post-mortem will identify President Trump’s ludicrously timed fiscal stimulus as a key trigger for the collapse,” Edwards said. “A ruinous fiscal deficit of 15 percent of GDP will be Trump’s legacy.”