The US economic outlook is showing some dangerous cracks. Photo: iStock

US stocks fell sharply Wednesday in response to trade war escalation, although they closed well off the intraday lows. The worse news is that the US economic outlook is showing some dangerous cracks. That creates a feedback loop of uncertainty.

President Trump has said repeatedly that the United States economy is doing well while China’s is doing badly. “Our economy is as good as it’s ever been, perhaps better than it’s ever been,” the president said on Thursday.

That isn’t quite true. Stripped of fluff, the 3.2% preliminary reading for first-quarter US GDP growth sinks to less than 1%, as I reported April 28. The Atlanta Federal Reserve’s GDPNow model projects second-quarter growth of just 1.2%.

Evidently, the president thinks that a strong US economy gives him leverage against China. That belief underpins his high-risk approach to trade negotiations. At some point his aides will have to break the news to him that the economy barely is growing. Will Trump then seek an accommodation with China? That’s impossible to guess.

Markit’s purchasing manager indices for both manufacturing and services, meanwhile, show virtually zero growth (a level of 50 means that an equal number of respondents are growing or shrinking). Analysts consider PMIs the most consistent and reliable indicators of future economic activity.

The plunge in the Markit services gauge took the market by surprise. Analysts had expected a reading of 53.5. The manufacturing print was the lowest in nine years. This is consistent with second-quarter growth of around 1%.

More ominous is the crack in long-term expectation as gauged by the bond market. The difference between the yield on inflation-protected Treasuries and ordinary Treasuries expresses the market expectation for change in the consumer price index.

Normally this hugs the movement of commodity prices, but it has diverged to the downside during the past several weeks.

The drop in inflation expectations sharply below the level indicated by commodity prices says that investors think corporations will lose pricing power over time due to general economic weakness.

The tech sector is 8% below its April peak, while real estate investment trusts and consumer staples – sectors with stable cash flows – have held up well. I continue to recommend ultra-safe sectors in the US market combined with buying Chinese stocks on dips.

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