Investors have already begun asking questions but we do not see drastic outflows from domestic equities as we test new highs, rather it seems that markets are ignoring geopolitical risks, (the June 12th meeting with North Korea has not solved the nuclear issues by the way). There should be a higher discount rate in riskier assets but this has not been the case. Rising rates and monetary tightening will lead to a defensive stance, in which case it may be better to get "ahead of the curve."
While first half growth in the U.S. was strong, we cannot forget about the $1.5 trillion tax cut, a wave that companies are still riding. With hundreds of billions going into spending bills, the government deficit has already increased 22% when compared YoY to the first 8 months of 2017. Investors have already begun questioning whether this is sustainable - pertaining both to our debt/GDP levels and our GDP growth. If more tariffs are to be put in place (in addition to this $16 billion levy on China expected at the end of August and China's tit-for-tat response), it is likely we will see more buying in advance of tariffs which makes it hard to deduce where we are truly seeing growth. In the longer term, this will result in lower growth both domestically, globally, and especially in China. China noted a recent rise in imports as well as exports this July though this increase is within the common trend we have seen and the trade deficit remains "normal". China will undoubtedly respond to these recent tariffs once they are put in place and one must ask, where will they turn after they run out of goods to tax? Does it become a matter of how low will they let the yuan go? Maybe a better question to ask is not how much the yuan will weaken but when will it become too hard for China's central bank to control the weakening? It should be noted that it is easier to reduce inflation than increase inflation.
Once tax cuts fade away, we will be situated in one of the longest expansionary cycles in history without much room left to grow. The market is not thinking about protectionism, the course which it takes and its effects on global supply chains and on company margins, both globally and domestically. Inevitably, protectionism leads to lower productivity, which leads to disinflation rather than inflation. Earnings have been strong, and have been led by strong margins (thank the tax cut), but large companies employing workers in the thousands have begun noting wage pressures which is interesting as we have not seen wages noticeably increase since 2015 when we saw some real wage gains for the middle class. Looking into the beige book we are beginning to see small signs of wage pressures increasing across the US, the following excerpts are from the most recent July 18,2018 Fed Beige Book: "Wages are now rising moderately - Philadelphia" - "Labor markets tightened, with wage pressures noted-Cleveland" - "Wages grew moderately-Minneapolis" - "Wage pressures stayed elevated-Dallas" and so on.
It seems we are in a stage of mass consumption with widespread consumption of high value consumer goods like luxury apparel and furniture and highly priced automobiles because consumers have high disposable incomes far surpassing the cost of basic needs, allowing them to buy these high value items. If you ask your average American, someone who doesn't follow market news closely - someone who watches the daily local news channel and listens to the radio on the way to work (I have asked several), they believe that the economy is strong, everything is going well, and they are thinking about their next car or thousand dollar phone or even getting their dog some coconut mango herbal organic shampoo for $25. We are in a high consumption phase and this will not be sustainable for more than a year or two at most. Not only is the market seemingly entering a "euphoria" phase typical in the last stage of growth (final hurrah!), but consumer confidence is strong and economic data points are not showing recession around the corner, though maybe these measures have been masked with everything unorthodox which has been going on.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.