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I will return: Donald Trump wants to return to the White House
Let’s prepare for a Trump presidency. We don’t know what will happen in the November elections. But we can begin to glimpse what it could mean for financial markets and – to be brutal – how we might prosper from it. In fact, I believe this outcome is already influencing stock and bond prices, and in the run-up to the election, that influence can only grow.
We don’t know any details of what economic policies a President Trump might try to implement. Also remember the old saying that, thanks to the separation of powers in the US, “the president proposes and Congress disposes.” It’s pretty clear that there will be tax cuts of some kind for higher earners and, more relevantly for investors, for the business community.
One idea he has supported is reducing the overall corporate tax rate from 21 percent to 15 percent.
Of course, the giant American companies don’t pay full freight, as there are all kinds of tricks they can use, such as booking profits overseas, etc., to reduce costs. Apple’s effective tax rate in the most recent quarter was 15.89 percent.
Still, America Inc would end up paying less in taxes, leaving more for shareholders and making heady stock valuations a little less lofty. A Trump victory would be good for stock prices. It would be bad for bonds and, other things being equal, for inflation.
There is no point in trying to play around with the impact on the US deficit that a Republican administration could have compared to a Democratic one. There are many other factors at play.
What we do know is that the federal fiscal deficit exceeds 6 percent of gross domestic product and has been on a deteriorating trend since the early 2000s, when it was last in surplus. We can also expect policy to remain lax, so the US government will continue to flood the world with its debt. The question is how willing investors will be to buy that debt.
Right now, 10-year U.S. Treasuries yield 4.3 percent, which would give a decent real yield if inflation does indeed fall back to the 2 percent target.
But let’s assume that’s not the case. The Federal Reserve would be under enormous pressure from markets to raise interest rates, which would collide with equally strong political pressure to keep them low.
Donald Trump said last month that he would not reappoint Jerome Powell as chairman of the Federal Reserve, suggesting that the rate cuts the Fed hopes to announce in the summer will be designed to help Democrats.
Powell has already served two terms and it’s not clear he wants a third term anyway, but whoever does the job, the result will likely be higher inflation. That’s bad for bonds. It’s also bad for the dollar, which has been held back by relatively higher cash yields than in Europe or the UK. If the gap narrows or reverses, then the argument for holding short-term surplus funds in dollars weakens or disappears.
How much of this is already priced into the markets? Bit. US stock prices, as measured by the S&P 500, have risen 8 percent so far this year, arguably coinciding with the increasing likelihood of a Trump victory. But the French equivalent, the CAC 40, is up 9 percent, and the German DAX is up 7 percent.
The UK is the rarity, with the FTSE 100 flat. What seems to have happened is that the market is no longer worried about Trump. Maybe lower taxes, maybe protectionism, but November is still a long way off and there are more immediate issues, particularly the timing of that first interest rate cut.
In any case, by historical standards, the bull market in the United States is only middle-aged and valuations are not crazy. Bank of America said last week that the market shows no signs of previous boom-and-bust cycles. If that’s true, then a Trump victory would be a plus for US stocks.
As for the bonuses, the question is how they would be received abroad. Foreigners own 30 percent of the US federal debt, with Japan the largest share and China the second largest. Japan is not going to dump its holdings, but China could start doing so.
That’s another reason to prefer US stocks, be cautious about bonds and feel that the dollar may not remain as powerful in the coming months.