Many of Donald Trump’s economic plans put forward during the presidential campaign seemed extremely unwise even to the corporate leaders who supported him and care about profits over everything else. Universal and large tariffs and mass deportations, for example, were clearly anti-growth policies that could hurt profit growth. Often, these corporate leaders and other campaign supporters pushed the narrative of a “stock market veto” that would keep the Trump administration from pursuing some of its most anti-growth policies. The thinking was that President Trump constantly invoked stock market increases during his first term as evidence of his good economic management, so any policy effort that could cause stock market declines would be quickly abandoned.
So far, the “stock market veto” has turned out to be nothing more than wishful thinking. In his second term, President Trump has continued to loudly proclaim his support for the anti-growth policies of broad and high tariffs and mass deportations. He has also added a new anti-growth twist of arbitrary and illegal firings of federal employees and cancellations of federal contracts. Finally, he has enthusiastically backed a U.S. House budget resolution that would slash disposable incomes for the bottom half of U.S. households. Besides being substantively unwise, these policy efforts have been undertaken with maximum chaos.
And the stock market has indeed rebelled. The S&P 500, for example, is down 8% in the last month.
This raises the question: Was there ever anything useful in the “stock market veto” view of the world? After all, there is no general correlation between stock market movements and what’s good for broadly shared growth, so it seemed odd to think a stock market veto would somehow come to the aid of the broader U.S. economy.
In what follows, we’ll present the good and the bad of stock market ups and downs and what they might mean for the trajectory of economic policy. In the end, it turns out that today the stock market and the economy are mirroring each other: Stock market weakness is reflecting broader economic weakness. In short, if there was ever going to be a “stock market veto” of broadly anti-growth policies, it is past time for it to kick in.
What does the stock market measure?
Most of the time when people are talking about the stock market, they are referring to an index that measures changes in the prices of stocks of a number of publicly traded companies. Examples are the S&P 500 index (which includes 500 firms) and the Dow Jones Industrial Average (which includes about 30 firms).
In theory, the stock price of any given firm reflects investors’ expectations about the returns they will see from holding its stock into the future. These returns include the annual dividends paid out from these firms to shareholders and the capital gain that would be available if shares were sold in the future (with the capital gain being the difference in price between when it is sold and when it was bought).
The stock market does not measure broader economic health
Because stock market prices generate a new data point every day (or even every hour), they tend to be discussed far more than broader measures of economic health. However, many know that the stock market has little to do with the economic health of U.S. households. For one, the stock market doesn’t tell us anything about jobs and wages. There are times when broad-based economic strength pushes up jobs, wages, and the stock market, and other times when broad-based weakness causes these all to fall together. But more often what is happening to stock prices gives us no insight into the wider economy. And as we will talk more about below, there are times when stock market strength can be a pure zero-sum transfer away from the wages of typical workers—reflecting stronger profits earned solely from successful wage suppression strategies.
Because most households depend overwhelmingly on wages from work as their primary source of income and not returns from wealth-holding, the stock market tells us nothing about these households’ economic situations. The wealthiest top 10% of households own over 85% of all corporate stock, and the top 1% alone own roughly 50%. Roughly half of all U.S. households have essentially zero invested in the stock market, even when including indirect investments they might have, like holdings in 401(k)s.
What causes stock prices to rise or fall?
There are dozens of reasons why an individual firm’s stock price might rise or fall. A drug company might announce the discovery of a new blockbuster drug. An oil company’s stock might rise if the global price of oil begins rising. For the stock market as a whole, it is usually macroeconomic trends that cause increases or decreases in stock indexes. But just because it is macroeconomic trends that drive overall stock indexes, this does not mean they always move in the same direction—sometimes favorable macroeconomic trends can push up stock prices, but sometimes they can actually push stock prices down.
Overall pace of growth
One macroeconomic influence that can affect stock prices broadly is expectations about the pace of economic growth in the future. If, for example, investors believe that economic growth will accelerate in coming years, this should (all else equal) lead them to believe that profits will accelerate, and this should lead to some combination of faster dividend growth or higher capital gains in the future. Expectations about the pace of future economic growth can be driven either by expectations of long-run productivity growth (how fast the economy can grow on average over long periods of time holding inputs fixed) or by expectations about the business cycle (i.e., whether the economy is about to enter or emerge from a recession).
Redistribution from wages to profits
A redistribution of income from wages to profits is another macroeconomic influence that affects stock prices. For any given rate of expected growth in corporate sector income, the value of owning stock rises if profit’s share of this income rises. A number of things influence this distribution of corporate income between profits and wages. A rise in monopoly power in product markets, for example, will boost profits and therefore raise the share of corporate income claimed by shareholders. Similarly, a decline in labor’s bargaining power in labor markets will also cause such a redistribution by boosting profits. For example, some estimates indicate that nearly half of the rise in real corporate sector wealth between 1989 and 2017 can be attributed to a zero-sum transfer from wages to profits.
Reduction in corporate income taxes
U.S. corporations pay income taxes on their profits. Reductions in this corporate income tax rate (either through legislation or tax avoidance strategies) will hence make any $1 in pre-tax income more valuable to investors, and this will broadly bid up the price of stock.
Interest rate movements
We’ve established that the price of a given stock represents investors’ expectations of the returns to owning this stock in the future. But whenever future gains must be assigned an economic value to compare with current values, one must use an appropriate discount rate, which measures how much more valuable $1 is today than $1 is a year from now. Even ignoring inflation, there are reasons for this discounting. For example, people are impatient and $1 in consumption today is valued more highly than $1 next year. Further, every $1 in consumption foregone today can be invested and yield more than $1 next year.
The measure of how much money invested today can earn over the next year risk-free is usually proxied by something like the rate of return to U.S. Treasury bonds, which are assumed to never default. As discount rates fall, the value of wealth today rises. This means that falling interest rates push up the current value (and price) of the stock market broadly. This effect is sometimes underrated in how powerful it can be. Say that you think stock prices generally reflect what investors believe returns will be over the next 10 years. In this case, a fall in interest rates from 7% to 3%—essentially the fall we have seen over the past 30 years in the U.S. economy—will boost the value of stock prices by almost 20%.
The Trump administration’s policy agenda is weakening the economy—
including the stock market
The real value of the S&P 500 rose a stunning 27% in the last year of the Biden administration. Further, the share of corporate sector income claimed by profits instead of wages remains extraordinarily high in historical terms. Despite this, many felt after the election that stock markets would continue rising during the Trump administration because they inherited a fundamentally strong macroeconomy that would continue to generate profit (and wage) growth. Further, the inflationary spike of the immediate post-COVID recovery was clearly over, and there seemed to be some room for the Federal Reserve to reduce interest rates.
There was zero concern among investors that the Trump administration would raise taxes on corporations, and even some hopes that they would be cut further. Finally, the first Trump administration was a never-ending assault on institutions and policies that provide bulwarks to typical workers’ leverage and bargaining power in labor markets. These assaults had been successful in keeping real wage growth lower than one would have expected based on historical experiences with unemployment rates as low as what prevailed in the late 2010s. In short, as long as the second Trump administration did not do something extremely stupid to upend the strong inertial growth they were inheriting, their tax policies and their policy aim of redistributing money from wages to corporate profits were expected to bolster stock prices.
And yet stock prices have been falling in the past month as the Trump administration’s policy agenda comes into clearer view. The agenda is anti-growth and inflationary—a rare and bad combination. Slowing overall growth will slow profit (and wage) growth in coming years, which will depress stock prices. The administration’s illegal cutbacks to federal employment and contracts—and the spending cuts in the House budget resolution (if passed)—will drag sharply on economy-wide demand. The chaotic tariff policy and threatened mass deportations will constitute a large and inflationary supply-side shock. This will both slow growth and provide a real obstacle to the Federal Reserve continuing to cut interest rates.
The current Trump administration has predictably launched a number of attacks on workers’ bargaining power, and these might prove effective in boosting profits at the expense of wages. But the profit share of income in the corporate sector is already starting from an extremely elevated level, making further increases likely harder to attain. Further, the effect on stock prices of any such redistribution will likely be overwhelmed by the broader downward pressures noted above.
If a recession caused by the Trump policy agenda (as well as by any consumption cutbacks spurred by the falling stock market itself) is sharp enough, the Federal Reserve will cut interest rates. Given what we noted about the powerful effect of interest rate cuts on stock prices, this could halt the fall in stock prices and even provide some slight rebound. But by then the damage to the real economy— households’ jobs and wages—will have been done.
In short, while the stock market isn’t the economy, the stock market declines we have seen in recent weeks are genuinely worrying. They are a symptom of much larger dysfunctional macroeconomic policy that will likely soon start showing up in higher unemployment and slower wage growth for the vast majority. If ever there was a time for the “stock market veto” to activate, it is right now.
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