And So It Begins (Again)

Trump 2.0 begins on Monday and what that will bring to financial markets remains far from clear. What we have seen thus far is that the stock market is generally positive about what is to come, and the bond market is generally negative.

The things that appear most obvious are that Trump 2.0 will be focused on positive action for business. While the extent of any deregulation is unknown, the trend will clearly be in that direction. That will benefit business in general, but especially energy and finance companies.

The attitude towards anti-trust is also likely to be a net benefit for business and mergers and acquisitions will likely face somewhat lower hurdles for approval. These two items are the basis for the bulk of the business optimism about Trump 2.0.

One of the biggest wild cards for Trump 2.0 will be immigration policy. The labor statistics would imply that any wholesale effort to deport illegal immigrants has the potential to drive labor shortages, and that is not good for the inflation outlook.

If we are willing to assume that the Bessent confirmation hearings this week reflect the beliefs of the incoming President, then we received a few hints of what is to come with regard to tariffs and taxes.

While the campaign rhetoric was all about blanket tariffs, since the election, that stance has been toned down. We would expect more measured tariff proposals, which would be welcomed by markets as it would help to limit the inflation threat from tariffs.

Bessent’s comments indicate that tariffs will be used for three purposes. The first is address existing unfair trade practices. The second is to raise Federal revenue, and the third is to influence non-trade objectives, i.e. as a negotiating tool.

Using tariffs as a revenue source is controversial. The new administrations view is that tariffs are only partially reflected in prices in the U.S. Tariffs would theoretically increase the value of the dollar, and foreign exporters would some margin contraction to maintain market share. Both of those things would serve as offsets to the impact of the tariffs on prices, but many economists will need to see it to believe it.

The one thing that appears certain is that U.S. pressure on China is about to be amped up. And this escalation in relationship stress has the ability to reap havoc in markets as it responds to headlines.

On the tax front, Bessent stated that the U.S. doesn’t have a revenue problem, it has a spending problem. That may be true if the Trump Administration is willing to address entitlements, but there is no indication that any politician is willing to confront that political career killer. If that remains the case, then we have a revenue problem too.

Bessent’s first order of business is to extend the original Trump tax cuts that are set to expire later this year. If those are not extended, then a tax increase will be in place for 2026 and that could be a tripping hazard for the stock market later this year. As for additional cuts that Trump proposed on the campaign trial, those are relatively meager compared with the original cuts.

The far-right wing of the GOP desires greater fiscal responsibility and could stand in the way of making the expiring cuts permanent and they are more of a threat to kill any additional tax cuts envisioned by Trump. It is important to remember that extending the current tax cuts is not a meaningful change as they are already in place. However, allowing those cuts to expire results in a very real tax increase, and it is not simply on the wealthy. It is only additional cuts that could be additive to the economic growth story.

We caution not to get too caught up in it at this point. It is important to remember that Trump, in his essence, is a negotiator and sees the world through the eyes of a negotiator. As such, it is difficult to take anything he says at face value. You just don’t know if he means it or if he is simply establishing a negotiating position. Does Trump really expect to buy Greenland? Almost certainly no, but if that opens the door to closer Greenland/U.S. relations, the comment serves a purpose. The last thing the U.S. desires is the Chinese or Russians establishing closer ties.

How It Ends

For investors, the first priority is to stay invested. Historically, changing your investing strategy based on political change has been unproductive. The outlook for stocks remains positive. Valuations are currently on the high side and a correction can happen at any time, but the outlook for profits in the Trump era lean positive and ultimately, that is what drives stock prices.

Bonds are a different story. We need to be on the lookout for renewed inflation, which is the enemy of bond investors. The stimulative Trump policies can be kindling for more inflation to come. The chart below (produced on Thursday) is the yield on the 10-year Treasury Note over the last 3 months. The rise in the 10-year yield is likely attributed to a rising term premium (the extra yield over short-term rates to compensate for inflation risk). We should also note that at some point (probably over 5%, give or take) bond yields become a headwind for stocks as high yields weigh on stock valuations.

It is these concerns that brought us to reduce our bond exposure substantively in 2024.  Our decision is based more around risk management as opposed to a raw market call.  The Trump administration has wanted to lower taxes and raise selective spending, but they will be limited by the US government’s fiscal situation, and the road to resolving this will be long and volatile. As a result, we felt it best to manage the portfolio volatility from the stock side, and allow the bond market and their vigilantes to settle their differences before adding them back in the portfolio.

Have a great week!

 

What We’re Reading

 

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All information has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. There is no representation or warranty as to the current accuracy, reliability, or completeness of, nor liability for, decisions based on such information, and it should not be relied on as such.

The views expressed in this commentary are subject to change based on the market and other conditions. These documents may contain certain statements that may be deemed forwardlooking statements. Please note that any such statements are not guarantees of any future performance, and actual results or developments may differ materially from those projected. Any projections, market outlooks, or estimates are based upon certain assumptions and should not be construed as indicative of actual events that will occur.

Past performance is no guarantee of future returns.

Different types of investments involve varying degrees of risk. Therefore, it should not be assumed that the future performance of any specific investment or investment strategy will be profitable.

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By: Adam