About That Stock Market

Policy has gone mad; why aren’t stocks down?

A very busy day yesterday, so a less comprehensive post than usual. Before I get there, a note: two more of my inequality primers are now free at the Stone Center site. The list so far:

Why Did the Rich Pull Away from the Rest? Paul Krugman, Understanding Inequality: Part I

The Importance of Worker Power. Paul Krugman, Understanding Inequality: Part II

A Trumpian Diversion. Paul Krugman, Understanding Inequality: Part III

Oligarchs and the Rise of Mega-Fortunes. Paul Krugman, Understanding Inequality: Part IV

Predatory Financialization. Paul Krugman, Understanding Inequality: Part V

Now on to my subject.

The great majority of economists, in both the academic and business worlds, believe that Donald Trump is pursuing destructive economic policies. He has imposed high tariffs, undoing the effects of 90 years of trade negotiations. His deportation policies are already creating labor shortages and supply disruptions in multiple sectors of the economy. His Big Beautiful Budget Bill, aside from being cruel, is fiscally irresponsible. Deportations will undermine Social Security and Medicare. His drastic cuts to scientific research will undermine U.S. technology, and hence long-run economic growth.

Yet after briefly plunging when Trump announced his Liberation Day tariffs, stock prices have fully recovered. So I am often asked how this is possible. If Trump’s policies are so bad, how can the stocks be up?

My usual response is “I don’t give investment advice.” I may follow that up by quoting Paul Samuelson’s famous quip that the market had predicted nine of the last five recession.

But I thought it might be useful to say a bit more about how to reconcile the resilience of stocks with analysis showing that Trumponomics is very bad.

First, the long version of Samuelson’s quip: Stocks are not now and have never been useful predictors of the business cycle. Even when there were good reasons to be worried about a coming downturn, it’s very hard to find cases in which the stock market gave advance warning.

The way I see it, during any given period the market is driven by a narrative, positive or negative. The current narrative is strongly driven by optimism about AI. And it takes a major shock to change a market narrative. Nothing in history suggests that we should expect a really strong stock market reaction to the kinds of warnings we’re getting so far about Trumponomics.

Speaking of which: While Trump’s tariffs are very bad, there is — as I wrote in Sunday’s primer — a tendency, among both economists and other observers, to exaggerate the damage done by protectionism. Uncertainty about tariffs is definitely depressing business spending in the short run, but in that primer I estimated that Smoot-Hawley 2.0 will reduce long-run U.S. real GDP by 0.4 percent. The Yale Budget Lab, with a more elaborate model, comes up with very similar numbers:

Source: Yale Budget Lab

Now, losing 0.4 percent of GDP forever is a big deal. But it’s not so big that it’s hard to imagine other factors boosting stocks enough that the market goes up rather than down. I’d argue that other Trump policies, especially the evisceration of U.S. science, will eventually have much bigger negative effects on growth. But as I’ve suggested, the stock market is a lot less forward-looking than people imagine, and you wouldn’t expect these disastrous long-run policies to show up in today’s S&P 500.

Finally, Trump isn’t the only thing driving the economy and the market right now. As I mentioned, the current market narrative is largely driven by AI. And as it happens, Trump’s economic reign of error has coincided with a huge surge in investment related to AI. Here’s real spending on information processing equipment, which basically reflects the frantic construction of data centers:

It turns out that this investment surge accounts for about half of U.S. economic growth in the first half of 2025. Without that surge we’d probably be looking at an economy at stall speed, that is, growing so slowly that it could easily slip into recession. And while stocks rarely predict recessions, they usually slump when recessions hit.

So if you ask why Trumponomics hasn’t caused a stock crash, one answer is that many of the market effects of Trump’s policies have been masked by the AI boom. In fact, there’s a pretty good case that if Trump hadn’t won and implemented his tariffs, we’d currently be dealing with overheating driven by AI spending.

Does this portend a future recession when the AI bubble bursts? Maybe. But that will have to be the subject of a future post, or maybe several posts.

Back to the question of how stocks can be up in the face of bad economic policies. To summarize my argument:

· The stock market isn’t actually a good predictor of the economy

· Trump’s policies are bad, but their medium-term adverse impact won’t be as big as many imagine

· The AI boom/bubble is masking some of the effects of bad policy

We’ll be paying for Trump’s bad policies for a very long time. But there’s no contradiction between that reality and a stock market that is holding up, at least for now.

MUSICAL CODA

Actually, do worry. But try to be happy anyway.