By John Goltermann, CFA, CGMA
“As a general rule, it is foolish to do just what other people are doing, because there are almost sure to be too many people doing the same thing.”
— William Stanley Jevons
With Trump about to take office, many wonder what his presidency may mean for investors. For a long time, the US economy and markets have been mostly independent of whomever occupies the White House, but today the threat of large, widespread tariffs is new, and it could potentially have an economic impact. Trump’s election took place with a relatively strong economy and with the stock market at all-time highs, but also at a time of record high debt, out-of-control spending, geopolitical turmoil and softening labor market.
Republicans, who will control both the Senate and the House, will likely support the bulk of the America First agenda. Very few truly knows what Trump will do when he enters office, but by all accounts, and given his previous statements and actions during his first term, Trump does believe that tariffs will be beneficial.
The Trump trade kicked into high gear and speculative appetite surged following his decisive victory on November 5. The S&P 500 hit a new record high, the US dollar strengthened, and Bitcoin rallied strongly. But gold, silver, energy stocks and foreign stocks all fell. Longer-term interest rates initially jumped on the prospects of greater US economic growth and expanding fiscal deficits but have since fallen 0.3% (for the 10-year Treasury as of this writing). All of this price action is reminiscent of what happened after Trump’s election in 2016 when stocks rallied and Treasury yields jumped from 1.8% to 3.2% by 2018, but then they fell to 1.5% by August 2019 because capital spending failed to rise after the passing of the 2017 Tax Cuts and Jobs Act (TCJA).
Today, given the fiscal situation, the prospect of tax cuts is much smaller than it was in 2017 when House Republicans had a 47-seat majority. And the potential for a negative impact from a renewed trade war is larger. It is likely that the TCJA, which is set to expire in 2025, will be made permanent in the next legislative session, but the TCJA is not new stimulus – extending it will just be a continuation of existing stimulus. Extending the TCJA is estimated to cost $5.35 trillion over the next 10 years. Eliminating taxes on overtime, tips and social security income will cost an additional $3.6 trillion over the next ten years.1 On the spending cut and new revenue side, it is estimated that revenue from establishing a baseline tariff and savings from eliminating certain departments, reducing waste and fraud, would benefit the budget by about $3.7 trillion over ten years. Of course, these are estimates and major uncertainty exists over what will actually be realized. The point is that significant deficits will likely remain.
A huge issue will be tariffs. Whether Trump will (or can) carry out a 10% across the board tariffs and 60% on imports from China is open for debate. The market consensus right now is that he will not but, given the trade war in his first term and his routinely comparing himself to William McKinley, tariff risk is probably underestimated. The Budget Lab at Yale estimated that Trump’s tariffs would reduce real income by somewhere between 2.4% to 9.4%. This would hurt lower income consumers the most because they spend high proportions of their income.
Trump refers to protective tariffs as though they are a way of improving the free market and says that they fulfill a need to keep money at home. He also says that another benefit of tariffs is to force foreign companies to relocate some production to the US. Those sound great but there are also concerns about tariffs increasing prices of goods that can be made cheaper and more efficiently elsewhere. What matters to consumers is the lowest price. Period. If companies do relocate to the US to avoid tariffs it could open up more jobs, but that is only a benefit if Americans can’t find jobs doing anything else. And any gains from new jobs would be offset by higher prices paid.
Besides trade, there are other issues that Trump will have to contend with: 1) Rising debt service costs from higher interest rates could necessitate spending cuts, which will have to come from social spending. 2) Reducing immigration and beginning deportations (if that happens) will reduce labor supply, but it will also reduce labor demand from the economic effect of a declining need for immigrant housing (mostly older multifamily housing), and their associated expenditures. And 3) Interest rates are in restrictive territory. 7%+ mortgages would be OK if home prices were more affordable and, like in the 1990s, the economy was in a disinflationary boom. But housing affordability is at all time low levels and business capital expenditures is declining.
Of course, removing regulatory burdens will help the economy tremendously. And in an optimistic scenario of no trade war, a reduction in the corporate tax rate from 21% to 15% (not a certainty) would raise S&P 500 EPS by 4% (according to Bank of America and Goldman Sachs). But this is less than how much the S&P 500 increased in the month after the election and overlooks the fact that before the election the S&P 500 was trading at record highs relative to both cyclically adjusted earnings and GDP.
A hugely important and underappreciated factor for markets is that the incoming Treasury secretary will need to refinance $15 trillion of borrowing (almost half the debt) in the next two years. Over the last two years, Janet Yellen refinanced most of the maturing debt by issuing T-bills (they mature in one year or less), which carry no price volatility. This pushed bond market volatility past the upcoming inauguration. This was a risky thing to do on her part. It did contribute to a rising stock market but now forces the Fed to err toward lowering the Fed funds rate and risk stoking inflation. So, bond volatility could be coming as the US has to refinance at much higher rates going forward (5-year Treasurys yield 4.5%). This will increase interest expense on Treasurys and put pressure on government spending — a huge part of our economy. Moreover, many importers will be frontrunning post-inauguration tariffs (and a possible renewal of port strikes) by buying lots of goods – possibly adding to inflation pressure (and interest rates) in the short run.
The point of all of this is not to be a Debbie Downer, but just to relay that Trump’s election by itself doesn’t solve many of the problems that pre-existed him and that caution is still in order. Much of the market optimism around Trump’s election is understandable, but some key realities remain. As such, we will continue to own well-priced shares of businesses that should produce high returns no matter what happens in the economy or markets. Our number one goal is to make money for our clients without taking large risks. And to do that, we need to consider factors that other investors are likely to be overlooking and not get swept up in the hype and enthusiasm of traders and speculators.
[1] Source: Committee for a Responsible Federal Budget