Trump 2.0 Implications and Outlook
Trump 2.0 Implications and Outlook
Last month, Trump won the US Presidential election winning all swing states giving him a solid majority in the electoral college while also winning the popular vote. Additionally, the Republicans retook the Senate with 53 seats and kept a narrow majority in the House. With the Republicans having control of both the White House and the Congress, investors want to know what this means for the economy and the financial markets. While the transition to Trump and the Republicans will not take place until January 2025, Trump has already nominated people to many key cabinet positions indicating he plans to “hit the ground running.” Furthermore, Trump attended the re-opening of Notre Dame in France and met with foreign leaders, essentially establishing control ahead of time. Finally, Trump made clear during his campaign the key priorities on which he will focus. Below are the issues we believe will have the most impact on the markets in order of when they will be implemented:
1. DOGE
2. Tariffs
3. Immigration reform/border wall
4. Tax Policy
5. Reduced regulation
6. Domestic Energy
DOGE (Department of Government Efficiency): Trump has already appointed Elon Musk and Vivek Ramaswamy to spearhead DOGE to reduce federal spending. While many commentators are skeptical to how much DOGE can save given that most of the Federal spending is relatively fixed (Social Security, Medicare/Medicaid, Defense, and Interest Expense), we believe they can find savings even in these programs by attacking fraud (Medicare/Medicaid) and waste (defense). In addition, the US has substantial bureaucratic bloat that can be reduced. For example, the US has 18 different intelligence agencies. This can be reduced to four: CIA for foreign, FBI for domestic, NSA for data gathering, and military for defense purposes. The education department can be removed since the focus has shifted away from education and towards politics. Other departments have overlaps. The secret service investigates money laundering but so does the justice department. Given the lapses the country witnessed this election cycle by the secret service, their focus should revert to protect and serve only. Already Joni Ernst, the junior senator from Iowa, has written a white paper outlining several key areas for savings.
While DOGE will be established immediately upon Trump taking office, it will take time to get recommendations implemented and for benefits to show, but markets will respond positively the higher the suggested cost savings. Importantly, a successful DOGE will reduce the deficit, ceteris paribus, and should aid higher economic growth by reducing red tape leading to higher tax revenues from the added growth. We believe DOGE success will ultimately lead to lower long-term interest rates for the US, again ceteris paribus.
Tariffs: Trump has threatened tariffs against several of the trading partners of the US, including 60% tariffs on Chinese products and 25% tariffs on both Canada and Mexico. The latter two to reduce the flow of illegal immigrants and drugs. While the magnitude of these tariffs is large and would negatively impact global trade and economic growth, and will increase US inflation, we believe Trump is using the threat of tariffs to strengthen his hand in negotiations as he is a transaction guy. He is a former CEO and co-wrote the book: “The Art of the Deal.” Already, Canada has increased the number of drones, helicopters, and personnel allocated to the border. Mexico has its own immigration problems on its southern border as many migrants from Central and South America comes through here on its way to cross into the US further north. In addition, the cartels have been a destabilizing force in Mexico and controls most of the human trafficking. Hence, we believe it is in the best interest of Mexico to strengthen its own borders, and this is what happened during Trump 1.0 when he threatened tariffs. Within days, the number of border crossings into the US declined substantially.
China is a much bigger issue and has larger geopolitical implications. Not only is China an economic competitor but has spent substantial money to upgrade its military in the last 15 + years and has started to threaten its neighbors. This includes plans to unite Taiwan by 2027. Furthermore, China has large internal problems given its one-child policy that has led to the population peaking and aging rapidly. In addition, the country’s real estate sector is in shambles with many units unfinished and people losing their deposits leading to government intervention. History has shown that when a country has faced substantial internal problems and is run by a dictatorship, it often resorts to foreign aggression to unite the country. Russia is just the latest example.
We think the US will add substantial tariffs against Chinese products both to harm China but also to raise US revenues and to attempt protecting American industries and jobs. While Chinese companies absorbed most of the costs of the tariffs under Trump 1.0, and yuan depreciation helped, leading to limited impact on US inflation, we believe this will be harder under Trump 2.0 since the suggested tariffs are higher. As a result, tariffs on China goods will make it harder for inflation to come down and could lead to higher inflation in the short-term forcing the FED to put interest rate cuts on hold. This could offset some of the benefits from DOGE listed above. Finally, China will retaliate with tariffs on its own and export bans on key material/components forcing US companies to source from other countries at higher prices. Again, this could make it harder for US and global inflation to decline.
Immigration Reform/Border Wall: One of the first items on Trump’s 2.0 agenda will be immigration reform and finishing the construction of a border wall. The first order of business will be to stop the flow of illegal migrants (and drugs) arriving to the US. The second order is to do something with the illegals currently residing in the US. This includes the deportation of illegals that have committed felonies or have had their immigration requests denied but have continued to stay in the US. It applies especially to gang members that are behind both drug smuggling and human trafficking. However, this does not apply to most illegal immigrants currently in the country, and a solution must be found for them. Many are currently working in key industries such as construction, hospitality, and farming/meatpacking. These industries would be devastated if all illegals were deported and it would also drive up the costs of housing and food, leading to higher inflation. As a result, we believe an amnesty program will be offered where “law-abiding” illegals will be offered temporary/probationary visas if paying a fine and back-taxes but they cannot apply for family reunions. However, for the system to work, legal immigration policies need to be updated and reformed since the current system does not meet the labor or security needs of the US. As a result, it has led to illegal immigration.
Tax Policy: Trump proposed many tax ideas on the campaign trail, including no tax on tips that Kamala Harris also supported. To begin with, we believe the “Tax Cuts and Jobs Act of 2017” that was effective January 2018 will be made permanent after 2025. Trump might also try to reduce the corporate tax rate from the current 21% to 15%, but this will only apply to US earnings and will therefore benefit small and mid-cap companies the most given their higher exposure to the US. However, it will incentivize companies to move more of their production to the US, which will be positive for US economic growth. Since we believe Trump will focus more on tariffs and immigration initially, we expect the major tax focus will be making permanent the 2017 reform, which will be positive for both economic growth and markets. We do not believe there is enough support for eliminating taxation of social security, or for auto workers. Finally, the current SALT deduction limit might be adjusted up for inflation but we do not expect them to be fully brought back.
Reduced Regulation: One of the success stories under Trump 1.0 was the reduction of red tape which aided stronger economic growth. This time, it appears Trump 2.0 will be much more aggressive in reducing government regulation to stimulate growth. Already, his nominations for certain key positions will be tasked with “cleaning house” and will probably coordinate heavily with DOGE. While this will be resisted tremendously from the inside and create negative headlines, including how it will hurt the country, removing unnecessary burdens on companies and people will free up capital and the “animal spirits” coined by John Maynard Keynes. Already, the confidence among US executives has improved on expectations of lower taxes and regulation, and several companies are reducing or eliminating their DEI programs and shifting their hiring and promotion focus to merit. The US is very innovative and has the largest and deepest financial markets. Lower US regulations will further enhance the competitive position of the US economy and financial markets.
Domestic Energy: Both Trump and his Treasury Secretary nominee are promoting drill, baby, drill for US energy. While this worked in Trump 1.0, we do not think Trump being elected will increase US drilling activity initially as the world has adequate supply and more production will lower oil and natural gas prices. The US is already the largest oil and natural gas producer in the world and is a net energy exporter. The energy companies have moved away from production growth to free cash flow generation, which means lower capital spending and more capital returned to shareholders. However, the Trump 2.0 administration will approve several LNG (liquid natural gas) plants in the US currently put on hold by the Biden administration. This will increase US natural gas exports later in the decade that will lead to higher natural gas drilling activity in 2-4 years to provide the completed plants with feed-gas. Furthermore, Trump 2.0 will be much more favorable to US pipeline construction and will remove mandates that risk increasing electricity rates substantially as seen in German and California. Relative cheap energy is a competitive advantage for the US and Trump 2.0 will keep it this way.
While Trump is not a “believer” in the energy transition and climate change, there will be increased demand for renewable energy coming from tech companies and crypto mining that will increasingly fund these projects. Combined with accelerating electricity demand, power supply from all sources will be necessary to meet this demand. As a result, we believe there will still be demand for renewable projects but government subsidies will be eliminated for future projects. This will hurt expensive projects such as floating offshore wind projects, but many land-based projects will move forward.
Conclusion: Lower taxes, regulations and government spending will be positive factors for the US economy and financial markets. Tariffs and immigration can go both ways. If done right, it would be positive for the US as it levels the playing field and raises revenues (tariffs) and improve law and order by deporting criminals while those wanting to work and abide by US laws get probation (immigration). If done wrong, it can hurt the US economy by adding inflation and disrupting key industries. Finally, Trump 2.0 will support US energy developments that will maintain the US competitive advantage of relatively low energy costs. In sum, Trump 2.0 brings positive energy to the new administration with a strong focus for change and finding solutions for key issues.
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