Private Client Letter | Special Post-Election Edition
/It has been two weeks since the national election and many of the inferences of a second Trump presidency are beginning to come into focus. With Republicans about to take control of the White House, the Senate, and the House of Representatives we can expect sweeping changes to many important policies impacting the future trajectory of the economy.
In this special edition of the Private Client Letter, I want to highlight what I believe investors should be focused on for the next four years. Regardless of an individual’s political affiliations or political preferences, as investors we all must assess the realities coming our way.
To begin, it is important to recognize how significant Trump’s victory was. Not only did he win 312 electoral college votes, but he also swept all seven of the swing states and won the popular vote. Nearly all voter demographics moved to the right. Our friend Brian Wesbury recently observed that New York state is now more “red” than Texas is “blue”.
Two-thirds (67%) of voters described the US economy as not good or poor, according to CNN exit polls. It is hard to overstate how much the electorate voted to shake things up in Washington.
As expected, the economy proved to be a primary consideration for voters thirsty for change. As is my tradition, I will leave the politics and social implications of a second Trump presidency for others to debate. My focus here, as well as all future commentary, will be on economic policies and how these policies will ultimately shape the investment environment in the years ahead.
Regulation
Federal regulations are requirements that federal agencies use to implement and enforce laws passed by Congress. These regulations are created through a process called "rulemaking" and are published in the Federal Register as they are passed. Failure to comply with regulations can result in fines, orders to cease certain activities, or even criminal penalties.
Many businesses believe the regulatory environment has become too costly overall and difficult to navigate. In addition to the direct expenses related to compliance officers and legal experts necessary to interpret and implement adherence, regulations often limit certain operational methods or require businesses to adopt specific processes, potentially hindering efficiency. They also can create delays in permitting, inspections, and approval processes.
It is estimated that the burden of satisfying regulations totals as much as 7% of current GDP. By comparison, the annual cost of interest on the country’s national debt equates to about 3.5% (Source: Brian Wesbury First Trust ROI Podcast 11/11/2024).
Perhaps the most significant (and most immediate) shift from Trump will come in how government regulates business activity in the United States. He campaigned on the promise of deregulation and making government bureaucracies less intrusive. Trump also has expressed a firm intention to rescind all unspent funds under the Inflation Reduction Act, a landmark climate law from the Biden-Harris administration. This act encompasses hundreds of billions of dollars in subsidies for electric vehicles, solar power, and wind energy.
As he did in his first presidential term, Trump intends to eliminate regulations and free up resources to be more productive. In time, the anticipated increase in efficiencies and productivity would be a boon for businesses across most sectors.
Federal Taxes
The Tax Cuts and Jobs Act (TCJA) was the largest tax code overhaul in three decades and was signed into law by President Trump on Jan. 1, 2018. For individual taxpayers, the law lowered several tax brackets, increased the standard deduction, and raised the federal estate tax exemption. Many tax benefits that helped individuals and families are however, scheduled to expire in 2025.
The TCJA slashed the so-called SALT deduction to $10,000 (state and local taxes). In the campaign, Trump vowed to not extend this limitation. The SALT deduction issue will likely be a hotly contested point of negotiation.
For businesses, the law created a single corporate tax rate of 21% (from 35%) and repealed the corporate AMT. These provisions do not expire. TCJA also allows full expensing of short-lived capital investments rather than requiring them to be depreciated over time.
President elect Trump will seek to make permanent most of the TCJA rather than allowing them to expire at the end of 2025. He has also vowed to eliminate taxes on social security, overtime pay, and on tips for service and hospitality workers.
For businesses, Trump has proposed lowering the corporate tax rate from 21 to 15 percent for corporations that make their products in America. If corporate tax rates were reduced from 21% to 15%, corporate earnings after taxes would increase by approximately 7%, assuming all other factors remain constant.
I expect Trump will seek to move quickly on tax policies and achieve most, if not all, of his targeted changes. While lower taxes overall will lead to higher federal deficits in the near term, it is believed federal tax receipts would eventually increase as future economic growth is stimulated by these policies.
Government Efficiency
One of the more intriguing and controversial developments stemming from Trump’s electoral win is the formation of the Department of Government Efficiency (DOGE) to be jointly led by Elon Musk and Vivek Ramaswamy. While the elimination of entire federal agencies would likely require Congressional approval, DOGE is expected to eliminate government inefficiencies and reduce the size of government overall.
It is important to note that DOGE is not a formal government department and can only make recommendations. This said, government in the U.S. has never been bigger than it is today and the opportunities for efficiency gains are immense. It is estimated that federal, state, and local governments now account for over 51% of the economy. Trump said DOGE will advise the White House on ways to reduce spending, cut regulations and “create an entrepreneurial approach to government never seen before.”
While it’s unclear precisely how the department will operate, I believe that shrinking the government’s share of the economy would have a profoundly positive impact on growth and productivity over a long period of time.
Merger and Acquisition Activity
The environment for large-scale mergers or acquisitions (M&A) has been very challenging during the Biden presidency. For better or worse, antitrust perspectives and policies have greatly limited such activity. The Biden Justice Department (DOJ) and the Federal Trade Commission (FTC) have been successful in blocking several high-profile acquisitions based on perceived violations of antitrust law.
Many proposed mergers hang in the balance as federal officials conduct antitrust reviews. FTC head Lina Khan said she wants to determine whether "partnerships pursued by dominant companies risk distorting innovation and undermining fair competition."
While I do not believe antitrust policies to be high on the list of priorities for the second Trump administration, I do expect his administration will pursue a sweeping deregulatory agenda affecting antitrust, including cutting funding and staffing of the antitrust agencies. I also expect the Trump administration to roll back the Biden administration’s signature "whole of government" approach to antitrust to the extent it increases regulatory burdens on U.S. companies.
The net effect of this shift would be to allow capital to flow more freely, unleash strategic synergies, and drive economic growth higher. When implemented strategically and regulated appropriately, M&A can drive long-term prosperity.
Tariffs
A tariff is a tax imposed on imported goods, collected at the border when a U.S. business or individual purchases a product from another country. By raising the cost of foreign-produced goods, tariffs encourage consumers to opt for domestically produced alternatives and allow domestic producers to raise their prices. However, these benefits to domestic producers (such as higher prices and increased sales) potentially come at a cost to consumers, including businesses, who face higher prices overall. Additionally, tariffs have the potential of creating dynamic inefficiencies, which reduce productivity.
President-elect Trump has promised to impose steep new taxes on trade, including a 10-20 percent tariff on all imports, at least a 60 percent tariff on Chinese imports, and a 25-100 percent tariff on Mexican imports.
While president-elect Trump may want to impose tariffs to encourage investment and work, I believe this area of policy is problematic and must be approached with caution. I also believe most of what president-elect Trump has said on the issue of tariffs may have been more about negotiating leverage than actual policy. This will be one area we will be watching very closely.
Energy
The U.S. currently produces record levels of energy and more oil than any other country. The November 5 election delivered a pivotal shift in the U.S. energy landscape and a reorientation in priorities from the Biden administration’s climate-centric policies to a focus on further maximizing domestic oil and natural gas production.
Trump promised to “remove all red tape” that he said has stranded oil and natural-gas projects, including speeding up the approval of natural-gas pipelines into the Marcellus Shale, an area under the Appalachian Basin known for its “fracking” potential that includes Ohio, West Virginia, Pennsylvania, New York and other states.
Still, Trump will have to contend with the Inflation Reduction Act (IRA) signed into law in 2022. This legislation created deeply embedded clean energy investments into the economies of red states and fostered new industries nationwide. With a Republican majority of 53 seats in the Senate, Trump lacks the supermajority of 60 votes necessary to overcome a filibuster, meaning a full repeal of the IRA is unlikely.
Trump has repeatedly said he will bring down prices by boosting oil and gas production. However, it is important to note that the dynamics of a global oil market are complex and a sustained reduction in oil prices may be difficult to achieve.
Inflation
While the Federal Reserve has spent most of the past two years attempting to reduce the rate of inflation (i.e. the pace at which prices are still rising), president-elect Trump has vowed to reduce prices for consumers.
Americans are spending significantly more now than they were when President Joe Biden took office. According to Moody’s Analytics, the average U.S. household needs to spend an additional $1,120 per month compared to January 2021 to afford the same goods and services.
While paychecks have also increased—about $1,192 more per month on average—this means many people are using their entire pay raises just to cover rising costs, leaving them breaking even rather than moving ahead financially.
It’s important to note that these figures are averages, and for many individuals, wages haven’t kept pace with inflation, making it even harder to manage rising expenses.
This said, I do not foresee wide ranging price declines for the economy. In fact, I remain concerned that the embers of inflation are still burning and that an overly aggressive easing of financial conditions by the Fed (lowering interest rates too fast) could bring about renewed inflation. Furthermore, tariffs (if enacted as Trump has suggested) can be inflationary in nature.
Conclusion
Trump is moving quickly to nominate his cabinet to head 15 federal agencies, which are responsible for the administration of federal laws. He will eventually name thousands of political appointees, most of whom do not require confirmation by any other branch of government. His victory earlier this month was decisive, and he has a lot of power to effect change.
Still, president-elect Trump’s actions are not always easy to predict. With only two weeks having passed since the 2024 Presidential Election, we find ourselves flooded in speculation about what a second Trump administration means for the United States and for the world.
In addition to the economic policies explored above, Trump has promised to make housing more affordable and to boost supply by getting rid of regulations that increase costs and by opening up some federal land available for large-scale housing construction. He has said he would temporarily cap credit card interest rates at around 10%, which is less than half the current rate.
Trump also promised to make the interest paid on car loans fully tax deductible. To assist aging seniors and their family members, Trump has said he would push for a tax credit for family caregivers. Also, he would shift resources to at-home care and end disincentives that lead to care worker shortages, according to his platform. Trump’s running mate, Ohio Sen. JD Vance, has floated beefing up the child tax credit to $5,000 per child, but the president-elect has not formally adopted that idea.
He continues to express support for Right to Work Laws, which allow workers to opt out of paying union dues. He will likely make business-friendly appointments in various agencies, including the Department of Labor and the National Labor Relations Board (NLRB).
Overall, I believe the net effect of the policies Trump has proposed will have a positive impact on the growth prospects for the economy – much like they did in his first presidency. Accordingly, corporate profitability should be heading higher in the coming years and the investment environment appears to be favorable.
This said, I believe expectations are running high and the equity market is currently overvalued. Most of Trump’s proposals will take time to implement and many will be modified through negotiations and the political process. Apart from his policies, certain economic and geopolitical risks remain in place and have the power to be very disruptive in the near term.
Given the momentum Trump enjoys coming out of the election, I expect him to move quickly and boldly. Still, it remains to be seen how much of his agenda will become reality. As all of this plays out, we are best served by remembering that the U.S. economy is phenomenally resilient, and how history demonstrates how prosperity is possible under either Republican or Democrat policies.
Clearwater Capital Partners’ commitment to you is unchanged as we transition to a new year and a new government. We will remain steadfast and disciplined as we evaluate the new information coming our way. We will always prioritize your objectives over all else. And, we will work tirelessly to help you navigate many important decisions as we strive for favorable outcomes.
Thank you for your continued partnership and the trust you have placed in us.
John E. Chapman
Tuesday, November 19, 2024
