Courtesy NBT Bank
By Kenneth J. Entenmann, CFA on November 6, 2024
After an emotional charged election season (and way too many advertisements!), the nation has thankfully provided a clear election result…no hanging chads, no contested ballots or riots on the National Mall. Our President Elect will be Donald J. Trump, and the Senate will be under Republican control, with only the degree of control to be determined. At the time of this writing, control of the House of Representatives is still undetermined, but the Republicans are likely to maintain the majority. A Red Wave! Like it or not, the results appear to be definitive. We can now turn our attention to what this means for the economy and financial markets.
While every election provides myriad promises, threats and forecasts of booms and doom, elections rarely have an immediate impact on the economy. Even in the case of a clean sweep, historically it takes months and often years for campaign platforms to be codified into law and implemented. Our economy is a $24 trillion behemoth, and it takes much to materially move it in the short-term. Nonetheless, this election does have some interesting focal points. Tariffs, taxes, and regulation to name a few and they have implications for the equity and fixed income markets.
Economists don’t agree on much, but they uniformly do not like tariffs. Tariffs are an anathema to free market advocates. All things being equal, tariffs increase the cost of goods and invite retaliation from other countries and reduce overall economic growth. In short, tariffs are seen as inflationary and anti-growth. However, this assumes an actual free and fair market, something that rarely exists in the real world. We live in a world where all things are not equal! In particular, China is not a free or fair player in the global economy. Nor are many of our “friends” in Europe. Are Trump’s threatened tariffs simply a cudgel for future trade negotiations, designed to get better trade metrics for the U.S. economy? It remains to be seen. For those who oppose tariffs, they need to explain how they will get the rest of the world to change their anti-free trade behavior. Even if the tariffs are fully implemented and are inflationary on the margin, there will be other counter acting policies that may mitigate the tariff impact. For example, tariff revenue could partially help “pay” for lower taxes on corporations and individuals. One could expect less overall Government spending as well. And perhaps a most Orwellian Dept. of Government Efficiency spear headed by Elon Musk!
Tax policy was another major differentiator of the two candidates. Given the Red Wave, there is more certainty on the tax front. In the first Trump term, the Tax Cuts and Jobs Act (TCJA) of 2017 was a major overhaul of the U.S. tax policy. Many of the major tax cuts from that act are scheduled to expire next year. The Harris campaign was clear that they would let the TCJA expire, resulting in significantly higher taxes on corporate profits and investments. With a Red sweep, it is highly likely that most of these tax cuts will be renewed. In particular, the Corporate Tax rate will remain at 21%. Trump has suggested reducing the corporate rate to 15%, but even a Republican controlled Congress will have trouble with a 15% rate. It would be unaffordable, especially if one wants to include the smorgasbord of Trump tax proposals (no tax on TIPS, Overtime, or Social Security benefits, interest deductions for car and student loans and even the State and Local Tax deduction (SALT).) Regardless of the ultimate tax policy, it is unlikely that taxes will be increasing. Importantly, the proposal of an onerous “Wealth Tax” on unrealized gains is most certainly dead. Tax policy is likely to be a net benefit for equity investors.
The Biden administration unapologetically ramped up economic regulatory oversight. The alphabet soup of regulatory agencies…the FCC, FTC, OCC, SEC, CFPB, DOT, DEC…were given significant power over the last 3 years. Conversely, the first Trump administration put in place a rule that required any new regulation be met with the elimination of 2 other rules. It is likely that a far more constrained regulatory environment is upon us. The Biden administration has been quite hostile to merger and acquisitions, particular in the Tech space. More M&A, less regulation…this should be good for stocks in the long run.
Taken together, the concept of better trade and onshoring of manufacturing due to tariffs, lower taxes and less regulation sounds great. Today’s post-election equity market rally (the Dow is up 1,400 points at the time of this writing) suggests the equity markets like the election results.
However, all of the above comes with a cost. The prospect of higher inflation and greater debt and deficits has resulted in a significant increase in interest rates. The yield of the ten-year Treasury note increased 20 basis points…today…to 4.45%! It has increased nearly .60% since the Fed first cut rates in September! This creates a dilemma for the new President and the Federal Reserve. Tax cuts sound great, but increase the deficit, at least in the short-term. With debt and deficits increasing, can the Fed continue to cut interest rates? The market fully expects the Fed to cut rates by .25% on Thursday. But Fed action impacts the short-term interest rate market. Long-term maturities are influence by inflation and the demand/supply dynamics for long dated Treasury securities. “Term premiums” are increasing, and that is an expensive problem when there is $35 trillion in debt outstanding! As this blog has long noted, this is a significant problem that does not have an easy fix. While the Fed will likely continue to cut rates in the near-term, higher long-term rates could prove to be a major impediment for the Trump administration.
In the short run, the equity markets have reacted well to the election results. Perhaps today’s rally is a ‘relief rally” due simply to the clean result. The prospect for improved global trade, renewed manufacturing activity, a business-friendly tax environment and a more growth oriented regulatory regime is indeed cause for celebration. In addition, the economy is on solid footing, with decent economic growth, full employment, better inflation numbers and lower short-term interest rates. What is not to like? However, longer-term, the debt and deficits are likely to constrain the new administration’s economic flexibility; interest expense is problematic and growing. In addition, the equity markets are trading at record high levels and very high P/E valuations.
By all means, let’s celebrate a clean election. At the same time, the equity markets are priced for perfection in an environment where there is plenty to worry about in the world. Once again, the message to investors remains the same; manage your expectations.