Much has been written about how the economy seems to move ever upward, almost impervious to the various issues facing the country. A foreign war? Not to worry. Out of control government spending and deficits? Well, the stock market does not seem to mind. Higher inflation? Focus on higher profits. Economic benefits being for the most part allocated to the top ten percent of households? Others will benefit as the positive economic effect of spending trickles down to them.
According to several journalists who cover the White House, the stock market appears to be an important indicator used by the administration in evaluating the perceived success of its policies. Traditional polling is suspect. Poll numbers can be slanted by the way a question is asked. The stock market, by contrast, cannot be influenced by any one person or group. For this reason, the positive returns of the financial markets are seen as the best validator of the White House’s direction and position on any number of issues.
Witness the two sharp but temporary declines in the stock market since the current administration took office. The unveiling of tariffs on any number of imported goods last year on April 2 caused a sharp falloff in stock prices. While the President argued that tariffs were a fee imposed on exporters for access to American markets, people quickly surmised that the tariffs would eventually be passed onto them in the form of higher prices. Add to this fracas the retaliatory tariffs imposed on other countries on American goods like wine and distilled spirits. This caused foreign demand to fall. Then China reminds the US that it has most of the capacity to mine and refine rare earths, a class of minerals needed in everything from armaments to server farms and requires a Chinese export license to buy. After the courts struck down the tariffs, the government has been slow to reimpose.
The second incident was concerning the closing of the strait of Hormuz in the US-Iran War. In the early days the stock market became nervous about the price of gasoline, fertilizer, and other products exported from that part of the world. In order to offset this, the administration kept talking about a resolution to the conflict in the form of a treaty. The talk culminated in market indexes hitting an all-time high last week when a memorandum of understanding was signed by both sides. This pact paves the way for a 60-day period to finalize a more permanent framework to end hostilities. While there is no assurance that the MOU will be honored, as violations of the ceasefire have already taken place, the stock market is currently willing to assume the best.
This is important, as recent research has shown that consumer behavior depends on a strong stock market in this way: when the market goes up, those who have appreciating assets feel better disposed to spend their cash, knowing the stock market will replace the funds spent and then some. When the stock market falls, people will cut back on their spending in order to maintain their net worth. Those in the 90-percent of households that have fewer investment assets have fewer ways to feel they are benefiting from the current economy. This is especially true of the households below the median, as they tend to have few to no investment assets, and spend most all their income on what they perceive to be necessities. Note that this is the reverse of the economic rationale. Strong economies are supposed to beget strong stock markets. Not the other way around.
This observation has several implications. Wealthy retirees contribute to the economy by spending more than they earn, which is for many little or nothing. In this manner they are collectively a private-sector stimulus program, for want of a better term. They do his by spending what they make on investments, pensions and the like. Add this figure to what parents sometimes advance their children to buy houses or the like, and there is a substantial source of economic funding here.
Less obvious is what would happen if this scenario were to reverse. The following questions are hypothetical considerations and should not be interpreted as forecasts or predictions. If stocks began falling, at least in the most popular sectors and index funds, for some amount of time, how long would such spending continue before it is curtailed? And if curtailed, how long would private sector revenues and profits fall before companies would have to resort to layoffs? And who would buy the ballooning volume of government debt needed to cover revenue shortfalls?
These are not questions currently being addressed by the majority of investors. New technologies like Artificial Intelligence (AI), quantum computing and the like are being held out as ways to provide either cost savings, new demand for labor or both. The Middle East issues are expected to resolve themselves, in spite of having no record of ever doing so. The duration and economic impact of these events remain uncertain. Countries like Russia and China are expected to be rational actors on the world stage. If such rationality had existed a century ago, World War II would never have occurred.
Like the Oceans, the financial markets are a big place. When there is a shift, best not be where others have decided to congregate en mass.
The Economy
Economic activity continues to send off mixed signals. There has been some uptick in economic activity, mainly to replenish the armaments used up in the middle east and Ukraine.
The US has also benefited from strong exports. Our close to self-sufficiency in oil has helped us to weather the closure of the strait of Hormuz better than most countries. The US has seen strong exports of fertilizer, energy products, petrochemicals, and some crops. Also, let’s not overlook the estimated $1 Trillion cost of building out AI and its economic impact.
Interest Rates
Interest rates firmed up after the Federal Reserve board meeting last week. Those who thought the appointment of Kevin Walsh as Chairman would result in a reduction in interest rates were given a lesson in that Walsh is but one of eleven board members who vote on the direction of interest rates short term.
In reality, there was not much evidence for a rate cut. Inflation is running closer to four percent from the board’s mandate of two percent. Many chalked the increase up to the effects of the Iran War. Some market participants believe that once the war is over inflation will decline. Aside from the dearth of evidence that a cease fire will hold, it seems far-fetched to believe the adversaries will resolve matters in any realistic amount of time.
Inflation
There is evidence that inflation pressures continue to mount. There is some evidence that fresh vegetables have resumed an upward path along with beef and other food products. Air transport costs are up more than surface carriers. Aviation fuel doubled due to the closure of Hormuz. Disease is taking a toll on cattle, and a lack of migrants makes harvesting problematic in some cases.
The Stock Market
It is simplistic but true to say that the appreciation of a given stock depends on more buyers than
sellers. In today’s environment, ten stocks make up 40 percent of the S & P 500. The demand for these stocks is principally through index funds. About the same percentage of stocks are considered technology issues. This is the highest for any sector since the 1870s, when 60 percent of the stock market’s value was represented by railroads, the high tech of its day.
The recent success of Space X in selling $65 billion in shares, and the other issuers waiting in the wings to cash out raises the specter that additional supply of stock will stall the market’s advance. Two other AI issuers, Anthropic and Open AI, hope to sell almost $40 billion of stock between them in the near future. And do not forget the $1 Trillion give or take, being raised to build out AI.
Then there are the countless number of companies that were taken out by Private Equity in the last 15 years. Many of these firms made good money when the cost of debt was low, but now are cash flow negative due to higher interest costs. Time to sell them back to the public.
Adding up all this supply in the US alone is a lot of stock. Foreign firms will want to raise capital as well. And let us not forget the US government, who plans to issue incrementally at least $2 Trillion in new debt each year plus roll over existing maturities.
In the 1970s, when government deficits were, by today’s standards so small as to be laughable, there was a term coined of “crowding out”. Essentially this meant that, with the demand for credit being so much greater than supply, the most credit-worthy borrowers will be stated first, and less credit-worthy borrowers will have to fight it out for whatever is left, usually by raising the interest rate the more marginal borrowers are willing to pay. There will not be enough credit to go around.
Warren M. Barnett, CFA
June 24, 2026
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