The Stock Market Vigilantes have spoken. They don’t like tariffs, and they don’t like mass firings of federal workers. That’s because they don’t like stagflation, and they fear that Trump 2.0’s focus on these measures could cause a recession with higher inflation.
They really didn’t like President Donald Trump’s message on Sunday during an interview with Maria Bartiromo on Fox News, as evidenced by today’s extreme selloff, which caused the S&P 500 to fall below its 200-day moving average (chart). He indicated that tariffs are here to stay. Only a few weeks ago, it was widely assumed (by us and others) that Trump would use tariffs as a temporary negotiating tool that would result in freer trade and a more level playing field for American exporters.
While the plunge in stock prices since mid-February is widely blamed on confusion about the implementation of tariffs, it is actually becoming clearer that Trump intends to use tariffs as a permanent weapon to force companies to produce in the United States, especially goods that he views as essential to national security, including steel, aluminum, pharmaceuticals, and semiconductors.
The result so far is a trade war with China and Canada that is likely to widen on April 2, when the Trump administration is scheduled to announce reciprocal tariffs around the world including on Europe and India. That has incited the Stock Market Vigilantes to go on the warpath, especially after Trump told Bartiromo: "What I have to do is build a strong country. You can’t really watch the stock market." Silly us: We expected him to look for positive reinforcement of his policies from the stock market.
Yesterday, we acknowledged that we can’t rule out that a bear market started on February 20. The risk now is that if the selloff continues, the negative wealth effect will increase the odds of a recession, which would widen the federal budget deficit and increase the debt-to-GDP ratio. Trump has proudly observed that bond yields have declined since he took office. However, he risks inciting the Bond Vigilantes too if a stagflationary scenario gets in the way of fashioning a long-term plan to narrow the federal deficit in Washington.
Trump also risks losing Republican-held seats in the mid-term elections, resulting in political gridlock during 2027 and 2028. Americans don’t take very well to pain in the here and now with promises of gains later. In other words, Trump’s "Golden Age" could be tripped up by stagflation. Veteran Democratic strategist James Carville recently advised Democrats to sit back and watch Trump self-destruct.
What should Trump do differently? He should settle for closing the border with Mexico and lowering oil prices for now. So far, both have been accomplished remarkably quickly. He should allow more time for his Cabinet heads to quietly and slowly pare their departments’ headcounts. Then he could focus on winning larger majorities in both houses of Congress to move forward with his Golden Age agenda.
For now, the S&P 500 is down 8.6% since its record high on February 19. That’s not too bad considering that MAGS (the Magnificent-7 ETF) is down 16.2%, led by drops in Nvidia (NASDAQ:NVDA) (-23.2%) and Tesla (NASDAQ:TSLA) (-38.4%).