The most urgent task facing investors in the wake of the 2024 elections is figuring out how much of the Trump agenda, as broadly outlined on the campaign trail, will be put into effect.
A full and literal implementation across taxes, trade and immigration could have unwelcome consequences for the economy in both the short and long run. A more partial implementation, (which seemed to be anticipated by financial markets last week), could net out to be positive for stocks and negative for Treasuries in the short run. However, even this more restrained policy path would likely result in sharply-rising government debt and the potential, in some areas, for building economic and market risks. For this reason and because of the further run up in the U.S. equity valuations in the wake of the election, investors would be well advised to continue to rebalance portfolios both across asset classes and around the world.
The Forces Shaping Policy in the Next Administration
In his press conference last week, Jay Powell made it clear that the Fed was not going to prejudge any policies that might be implemented until they were outlined in detail and on their way to being enacted. In his words, “We don’t guess, we don’t speculate, and we don’t assume”. Unfortunately, investors don’t have the luxury of waiting that long and so have to make some base case judgements on what will or will not be implemented.
An assessment of probable federal government policy, over at least the next two years, should start with the election results themselves. In the end, despite very close polls going into election day, it was a decisive Republican sweep. Donald Trump easily won both the electoral college and the popular vote and, while counting is continuing in a few areas, it appears that Republicans will end up with a 53 to 47 majority in the Senate and a roughly 222 to 213 majority in the House of Representatives. With the White House and a comfortable majority in both Houses of Congress, a naive assessment might be that the President-elect would simply do everything he said he would do on the campaign trail.
However, this seems unlikely. A newly-elected President Trump will have less personal motivation to implement many of his campaign promises since he cannot run for office again. By contrast, those who have his ear, including big donors to his campaign, some foreign leaders and Republican members of Congress will be very motivated to further their interests. Seen from this perspective, a good question to ask, on any agenda item, is how much it might further the interests of interested parties.
Taxes and Deficits
One critical issue for markets and the economy going into 2025, will be how the Administration approaches extending those tax cuts from the 2017 Tax Cut and Jobs Act (TCJA) that were set to expire at the end of next year. A bill will likely wend its way through Congress over the course of next year containing the answer to this question.
It is reasonable to assume that current rates on individual and corporate income taxes and on the estate tax will all now be extended, including a continuation of annual inflation indexing of exemptions and tax-bracket thresholds. President-Elect Trump has also made it clear that any tax bill would allow the cap on SALT deductions, which funded a small part of the 2017 tax cut, to expire on schedule at the end of this year, adding to the cost of the bill although benefiting more affluent homeowners.
In addition to this, President-Elect Trump promised a further cut in the corporate income tax rate from 21% to 15% for “domestic production”. Such a tax cut would obviously boost the after-tax earnings of both public and privately-held corporations and they can be expected to lobby hard to achieve both the cut and a very broad definition of “domestic production”. In addition, business interests will argue that the President should follow through on his promise of a renewal of full expensing for investments in equipment and R&D, again for domestic production.
Some of the other campaign commitments will be harder to implement. The promises to eliminate taxes on tip income and overtime would be extremely expensive even if they didn’t change the behavior of management and workers. However, inevitably, both would game the system, claiming that more worker income was, in fact, tips or overtime, further boosting the cost. Because of this, a Republican Congress might be tempted to leave these items out of a broad tax bill. That being said, Democrats in Congress might try to add them back in and would surely highlight Republican attempts to omit them, if they occur, in future election campaigns. Consequently, despite their cost, a reasonable baseline forecast is that they will be included, although perhaps watered down to some extent.
The proposals to allow for the deductibility of interest on auto loans and the elimination of taxation on social security are more straightforward from a definitional perspective and so might also make their way into the tax bill. All told, the overall cost of this tax bill would be enormous and reckless in the context of our long-term debt outlook. However, the interests of interested parties will tend to push it up. The problem is that while everyone may decry the long-term trajectory of the federal finances, each interest group will have a heavy incentive to get their particular tax break and voters have made it clear that they will not punish the fiscally reckless or reward the fiscally prudent.
There are at least three possible areas in which the new Administration and Congress might attempt to pay for at least some of the cost of these tax cuts.
First, President-Elect Trump has proposed having Elon Musk head an effort to cut government spending. However, it should be recognized that if Social Security, Medicare, Medicaid, Veterans Affairs, Defense and interest payments are off the table, there is actually very little of the federal budget left to cut. Moreover, almost every area of federal spending has powerful defenders among Republican as well as Democratic senators and House members.
Second, President-Elect Trump is likely to cut aid to Ukraine and possibly to NATO. However, while this may result in some savings, there will again be powerful advocates of military spending among Republicans in Congress who have military bases or armament production facilities in their districts and President-Elect Trump has also vowed to increase troop pay and invest in advanced military technology.
Third, President-Elect Trump has said that revenue from tariffs would fund tax cuts. The problem with this is that higher tariffs, by inviting retaliatory tariffs, would slow the economy, reducing revenues from other areas of income taxation.
So, in short, the tax bill is likely to amount to significant fiscal stimulus and add to deficits with no major revenue or spending offsets. According to the Committee for a Responsible Federal Budget1, a full implementation of President-Elect Trump’s proposals could boost the debt to GDP ratio from 98.2% of GDP in fiscal 2024 to 143% of GDP by fiscal 2035. That being said, because of the way it will likely be enacted (through the once-a-year budget reconciliation process) its provisions would likely not take effect until the start of 2026. In addition, as was the case with the 2017 Act, the 2025 Act will very likely include a sharp sunsetting of tax cuts within a 10-year window in order to avoid a filibuster under Senate rules.
Tariffs and Immigration
Two areas where the policy bite may be less severe than the campaign bark are tariffs and immigration.
On tariffs, President-Elect Trump said he would impose a 10% tariff on goods imports from all countries and a 60% tariff on goods from China. While he seems to be actually attracted by the idea of tariffs, there are reasons to believe that any actual implementation would be less severe.
First, higher tariffs would be passed through to consumers in the form of higher prices and this would be particularly unpopular with the U.S. population following the inflation seen earlier this decade. These price increases could also boost long-term interest rates, including mortgage rates, and might cause the Federal Reserve to slow their easing.
Second, any higher tariffs imposed early next year would be immediately met by retaliatory tariffs from other countries, hurting U.S. exporters and commodity producers. Moreover, this would occur before any fiscal stimulus arrived from any tax bill passed in 2025 and could slow the U.S. economy or even put it into recession. This would not be an easy situation for Republican members of Congress ahead of the 2026 mid-term elections. And while President Trump essentially implemented his first-term trade agenda without congressional approval, it is very doubtful that he could legally do so with the more expansive measures he proposes for his second term2.
Third, business leaders have decidedly mixed views on tariffs. Some would oppose them in general on economic grounds, some would like to see them imposed on their competitors and some would like to see carveouts to avoid putting tariffs on their own suppliers. In addition, the U.S. couldn’t put new tariffs on Mexico and Canada under terms of the USMCA agreement that needs to be renegotiated in 2026 and the U.S. would likely have to engage in negotiations with many other countries in favoring some nations and disfavoring others. The interests of interested parties would likely water down any new round of tariffs although even a watered-down version could be harmful in terms of inflation, economic growth and general business uncertainty.
On immigration, President-Elect Trump has promised mass deportations. Deportations might well rise. However, business leaders will continue to point out the necessity of having foreign labor available given almost zero growth in the domestic, working-age population. There is also a distinct possibility that a Republican Congress will take the opportunity to pass an immigration reform act which, while tightening the rules on asylum-seeking in the U.S. and shutting the southern border to new undocumented migrants, finds ways to keep current migrants working in the U.S. economy.
Regulation
Part of the reason for the Wall Street rally following the election was, undoubtedly, the promise of less regulation. It may well be that the Trump Administration delivers on this promise, reducing environmental and health regulations, constraints on the housing, energy and tech industries and regulation in the financial industry. All of this would tend to boost corporate profits somewhat.
However, investors should be a little careful what they wish for in this area. Fewer environmental regulations would generally boost corporate profits. However, a lack of any U.S. commitment on global warming would severely limit the world’s ability to deal with this problem with potentially disastrous long-term consequences. A lack of financial regulation, taken to an extreme could eventually lead to a financial crisis as it did in 2008. The severe anxiety issues being caused by social media, particularly for young people, probably call for more regulation rather than less. Moreover, while everyone has their own opinions on these issues, from my perspective, the proliferation of on-line gambling, crypto currencies, semi-automatic weapons and marijuana dispensaries are a negative, rather than a positive, for society.
The basic problem is that with deregulation, the beneficiaries are generally a small group of interested parties who will be particularly adept at getting their own way while long-term costs are borne by society as a whole.
The Long-Term Danger in Interested Parties
Under these assumptions, in the short-run, the economy may well stay on a similar path to 2024. In the absence of any immediate fiscal stimulus, mass deportations or significant tariff increases, the economy could continue to see moderate growth, a low unemployment rate and inflation in the vicinity of 2%. Long-term interest rates would be higher due to the anticipation of fiscal stimulus in 2026. However, the prospect of further deregulation and tax cuts might well support investment spending and the stock market.
However, in the long run, there is great danger in an economy run in the interest of interested parties. These groups, whether ideological, political or simply commercial, generally have an interest in the government imposing less regulation, lower taxes and higher spending in specific areas. In the long run, this can degenerate into an ever-more unequal and indebted nation with less dynamism and greater risk of bubbles.
This may be where America is headed. Or it may turn out to be too gloomy a view of the future. However with the S&P500 now selling at over 22 times future earnings, with 10 companies now accounting for 37% of its total market cap and with U.S. equities now accounting for 65% of the global stock market, the risk that the U.S. will head down this path clearly justifies a more cautious and globally diversified approach.