Photo: AFP / Johannes Eisele

Today’s strong performance on Wall Street (S&P 500 up 1.33%, Dow Jones Industrials up 1.5%) shows how much weight investors place on the threat of yet another government shutdown. Republican and Democratic lawmakers today reached an agreement in principle, although President Trump tweeted that he is “not happy” with the outcome and will try to tweak it before signing on. Nonetheless, market indices jumped on the news.

Today’s price action emphatically had nothing to do with the China trade talks, which remain a riddle wrapped in mystery wrapped in an enigma. The popular ETF proxy for Chinese H-shares, FXI, ended the day barely changed. That’s a departure from the prevailing pattern during the past several weeks in which FXI led the S&P as optimism about a prospective US-China trade agreement buoyed markets.

There’s no news out of Beijing, where US and Chinese trade negotiators are at work, but Secretary of State Mike Pompeo threw a bomb in a Tuesday speech in Hungary. Pompeo appeared to threaten a boycott of US high-tech exports for countries who use Huawei equipment in critical infrastructure.

“If that equipment is co-located where we have important American systems, it makes it more difficult for us to partner alongside them. We want to make sure we identify the opportunities and the risks with using that equipment. And then they will get to make their decisions.” That is hardly a practical threat, given that no US company now makes 5G broadband equipment, but it does raise the temperature.

The biggest winners in today’s feeding frenzy were the large-cap technology names. Netflix led the S&P 100 with a gain of over 4% on the day. Any rally that begins with Netflix—now trading at 134 times trailing earnings—exhibits a degree of derangement, in my view.

On the ground, there are reasons to worry about the US economy. The US economy is the leper with the most fingers among the industrial nations, and the one finger that is functioning is employment. The trouble, as I reported last month, is that more than 100% of the 200,000 or so new jobs that the US has created each month come from small business, at the bottom end of the pay scale—leisure and entertainment, healthcare, and business services. Listed companies are shrinking employment. The National Federation of Independent Business, the best source of data on the condition of smaller enterprises, today reported a sharp drop in business optimism as well as hiring plans.

Given the economy’s dependence on small business, that’s a danger sign. Here again is the chart I published in January on small vs. large company total employment:

Risks to the US economy are now skewed to the downside. CapEx is weak, housing is weak, and the trade deficit is likely to rise with the strong dollar. The only tailwind behind the US economy is employment growth, and if that falters, economic growth will decline with it. That doesn’t foreshadow a recession in 2019, but it does mean that the Wall Street consensus for an earnings rebound in late 2019 will be disappointed.

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