The electoral votes have been counted. Congress has certified. Cabinet members have been nominated and are being confirmed. The inaugural parade made its way to the White House. The Trump Train has arrived.
Change is what happens over time, and it’s also what makes investing interesting and challenging. But unlike polarized party politics, the potential economic implications of the Trump administration are much more nuanced. In our view, Trumponomics holds within it the potential for big surprises, to both the upside and downside.
A Modest Boost to Growth
Much has been written and said about the incoming president’s platform and agenda. The shorthand of Trumponomics includes a significant increase in government spending focused on infrastructure, major tax cuts for both individuals and corporations, rolling back existing (and limiting future) regulation, and on-shoring jobs with the threat of tariffs for unfair trade practices.
On the surface, there could be much here for advisors and investors to like. Post-financial crisis, the U.S. – and much of the globe – have fallen into a growth funk. The recovery and expansion since 2009 is renowned for being the weakest in modern economic history. More spending, lower taxes, more domestic production, and less regulation will be a supply-side cure to our secular stagnation, right?
Maybe. The Trump agenda has the potential to create a more favorable macroeconomic landscape. It could increase growth, push up inflation, and boost business performance (i.e., revenues and earnings). This positive outlook was reflected by markets in the early weeks after the election with real rates, stocks, and the U.S. dollar soaring. But easy solutions to complex economic challenges are hard to come by. Even with both houses of Congress in line, legislative progress will take time. Infrastructure projects have to be planned and even simple tax reform can get messy. Deregulation can create unintended consequences. Moreover, Trumponomics can’t immediately reverse weak labor force growth in the U.S. (and much of the developed world) resulting from an aging Baby Boom generation.
Productivity: The Linchpin of Optimism
So what does the “Trump upside” look like? Lower individual tax rates could boost personal consumption, while infrastructure projects would require a boost in government spending. But our hopes within the Trump agenda rest largely on jumpstarting productivity growth, which has been weak for several years. Infrastructure spending could provide a short-term jolt, but its real upside will only come if it’s correctly targeted at improving the long-term productivity of the economy. This includes projects like transportation upgrades, greater access and bandwidth across technology, better education and worker (re)training, safeguarding clean air/land/water, and improving cyber protection and reliability. In short, solving 21st century problems. Alternatively, bridges to nowhere, pork-barrel Congressional favors, and fruitless attempts to bring back low-skilled industries will fail to create any lasting effects, other than to increase fiscal deficits.
Second, lowering corporate tax rates will, by definition, improve corporate profitability. That improvement could stoke capital expenditures, which have been sub-par for several years, thereby improving productivity, or so the theory goes. Will corporate executives flush with higher after-tax profits reinvest in their businesses? Or will they simply return those profits to shareholders in the form of dividends and stock buy-backs? This of course will depend on the business environment. Here, a wide-ranging deregulatory agenda could prove most important. Without doubt, red tape has taken its toll on business (particularly small business) in recent years. The U.S. economy has lost dynamism and business formation has languished. It is likely that the new president’s pro-business, anti-regulation message is being viewed enthusiastically by entrepreneurs and CEOs.
Now, the Downside…
Larger deficits tend to be inflationary, and major spending programs could push up wages in an economy already approaching full employment. This has the potential to raise inflation fears and interest rate risk.
On trade, Trump’s “America First” protectionist ideas fail even a basic understanding of macroeconomics and put at risk what is otherwise a relatively strong pro-growth agenda. When properly measured, trade raises wealth and living standards in aggregate – not for everyone, but on average. In a world where global trade is already flagging, a trade war between the world’s two largest economies (the U.S. and China) is potentially a recipe for disaster. Due to higher income standards, the U.S. has few competitive advantages in low-skilled manufacturing. Punitive tariffs are unlikely to change this. Instead, they may simply drive up the costs of imports or worse, hurt the export sectors through retaliation where the U.S. does have competitive advantage. Trade wars have no winners, no matter how popular they sound at home.
Trump’s pro-growth policies could also have unintended consequences. While a broad platform of deregulation may help unlock entrepreneurial spirit, it could also come with some fallout. Repealing Obamacare may alter the behavior and productivity of citizens who lose coverage. Sweeping changes to energy or environmental policy could reduce safety or the quality of life. Financial deregulation may increase financial system risks for investors and taxpayers, and so on.
The Trump Factor
Love him or hate him, there are some characteristics of the new president that are not in dispute. He is politically inexperienced. His style is to be outspoken and reactive. He is more confrontational than diplomatic and is willing to make both news and policy via Twitter. None of these characteristics are necessarily fatal flaws. In the right situation, some of them could be strengths. They do, however, increase the risk of policy or execution errors.
Outlook: Underweight Confidence
President Donald Trump is a game-changer. The upside and downside extremes of his policies, along with his inconsistent and often contradictory views, defy traditional methods of analysis. Forecasting is difficult under the best conditions, and he has no historical equivalent. Be wary of anyone who says they know what he’s going to do, much less what it will mean for the economy or markets.
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This material is provided for informational purposes only and should not be construed as investment advice. The views and opinions expressed above may change based on market and other conditions. There can be no assurance that developments will transpire as forecasted.
Understanding current market conditions and what might be expected in the near term.
Understanding potential market trends in early 2017 requires a look at the market’s recent optimism.
During periods of market optimism, remaining mindful of risk is still important.