The trifecta has been set. Trump has captured the White House, accompanied by a Republican controlled Senate and House of Representatives. Now that the election is behind us, investors will attempt to evaluate the political impact on financial markets. How will the policies change investment markets? How will interest rates respond? What are the spending initiatives and how will they impact industries?
During the closing weeks of election season, markets began pricing in a probability of a Donald Trump victory. The so called “Trump trade” prompted an uptick in bond yields. This is due to expectations that more protectionist leaning trade policies could accelerate some domestic-oriented segments, while increasing inflationary pressures. At the same time, certain equity sectors received a boost from less regulatory scrutiny and a continuation of the 2017 tax cuts.
Markets hate uncertainty. With the results known, we could see some degree of easing in the relatively high market volatility. Nevertheless, we expect political trends to continue affecting markets. Multiple military conflicts around the world could continue rattling investors’ nerves. The potential for tax policy changes, ongoing debates over fiscal policy and the debt ceiling as well as other lingering issues could mean ongoing uncertainty.
Regardless of how the congressional control dynamics play out, we are likely to see a significant tax package next year, given the impending expiration of numerous individual tax provisions from the 2017 Tax Cuts and Jobs Act (TCJA). With the “red sweep,” President Trump will likely push to extend several key provisions of the TCJA, including the current marginal tax rate levels for high-income earners. We also expect some efforts to reduce clean energy tax credits and scale back IRS enforcement. Republicans may also push to reduce corporate tax rates from the current 21% and could move to tax private university endowments.
The wildcard for tax policy is tariffs, which Trump promoted during his campaign. President Trump will have significant ability to enact tariffs unilaterally via executive action, and it would not be surprising if his administration makes this an early priority. Specifics remain unclear, but we anticipate tariffs on Chinese goods and a broader move toward a more protectionist tariff policy. Should they come to pass, domestic production would increase, and we would likely see some benefits to small-cap U.S. stocks. Inflationary prognostications are worthy of consideration but may be premature as the effects of promised reduced regulation and AI implementation are inherently deflationary. Higher inflation could put upward pressure on bond yields and may slow the pace of U.S. Federal Reserve rate cuts.
Regardless of potential shifts in tax rates, investment-related tax planning remains an important consideration. Tax-loss harvesting, tax free municipal bonds, tax efficient ETFs, asset location, and other tax management strategies will remain pertinent.
While market valuations and company-specific fundamentals are more important than politics, the change to a Republican administration is likely to result in a shift in the regulatory environment for the financial, energy, and healthcare sectors. It is not a surprise to see bank stocks leading the way in the rally that started after the results were known. We may also see increased investment in traditional oil and gas exploration, which would serve as a relative benefit to those areas of the market. We will continue to monitor how actual governance differs from campaign chatter.
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