The outcome of the U.S. election has once again captured global attention, similar to the surprising 2016 victory of Donald Trump. This time, the shock was less about his win and more about his ability to forge a diverse coalition of working-class voters, allowing him to secure the popular vote.
In 2016, Trump’s victory caused the stock market to surge as investors anticipated tax cuts and deregulation, which were expected to spur economic growth. This time, the market’s initial response has mirrored that, with the largest weekly gain in two years.
However, it remains uncertain how long the market’s optimism will persist. As John Authers from Bloomberg points out, the stock market is currently as expensive as it was during the 1928 presidential election. The ultimate effect on the market will depend largely on how the economy fares over the next few years.
John Authers warns of stock market valuation levels akin to 1928
On a positive note, the economy today is in much stronger shape compared to eight years ago, when it was still recovering from the 2008 financial crisis. Since then, the U.S. economy has outpaced other developed nations, with inflation nearing the Federal Reserve’s target of 2%. As a result, the Fed has been able to cut the federal funds rate by 75 basis points in its last two meetings.
Nevertheless, Treasury yields have risen by about 80 basis points since September, driven by concerns over budget deficits. The federal debt has increased by $15 trillion in the last eight years, reaching a total of $35 trillion.
Looking ahead, the combination of tax cuts and tariff hikes that Trump is considering could potentially increase the federal budget deficit by $7.5 trillion or more over the next decade, according to the Committee for a Responsible Federal Budget. As a result, bond yields are expected to remain higher than they were during Trump’s first term.
Before the election, it was unclear what legislative changes could occur. However, with Republicans now holding a comfortable majority in the Senate and a narrower lead in the House, the likelihood of extending parts of the Tax Cuts and Jobs Act and making changes to the tax code has increased.
Beyond these potential moves, Republicans would be taking a risk by pushing through the sweeping tax cuts Trump campaigned on, especially if bondholders are hesitant to accept them.
One of the biggest uncertainties now is whether Trump will follow through with his pledge to raise tariffs on Chinese goods by 60% and increase tariffs on other imports by 10-20%. While economists have warned that this could severely disrupt global trade, many investors view it as a negotiation strategy. To gain insight into Trump’s likely actions, investors should pay close attention to the key figures he appoints to his economic team.
Robert Lighthizer, who served as Trump’s trade representative during his first term, is expected to play a role in shaping trade policy with China and Europe. Lighthizer’s views on trade have become more hardened, with reports suggesting that he might advocate for introducing Trump’s tariff proposals shortly after taking office.
Lighthizer has also been a proponent of devaluing the U.S. dollar to improve the competitiveness of U.S. businesses in international markets. There are also reports that Trump’s Wall Street backers are urging him to appoint a treasury secretary with a deep understanding of the financial sector. This role oversees critical areas like international economic policy, exchange rates, and fiscal policy.
The leading candidate for this role is Scott Bessent, a billionaire hedge fund manager who has earned respect in the financial world. In a recent Wall Street Journal op-ed, Bessent praised Trump’s economic policies and emphasized the importance of letting the private sector drive capital allocation. He also argued that restoring confidence in the economy and preserving the dollar’s global status is key to maintaining sound fiscal policies.
Bessent has previously suggested that tariffs should be gradually implemented, allowing any inflationary impacts to emerge slowly, with counteracting deflationary policies such as deregulation. He views tariffs as a negotiation tool to force concessions from trading partners, believing they should be phased in over time.
This could create a conflict within the White House between those advocating for a hardline tariff approach and those favoring a more pragmatic stance. According to the Washington Post, early personnel battles are already shaping up between Wall Street-friendly Republicans and trade hardliners supporting high tariffs.
It remains uncertain which group will prevail, but there is speculation that Trump may initially side with the hardliners due to his longstanding support for tariffs. If that happens, the financial markets may become the final judge on whether he has gone too far.
In his first term, Trump was forced to revisit trade negotiations with China in 2019 after the trade war triggered a market sell-off. The market rebounded when an agreement was reached, with China agreeing to buy an additional $200 billion in U.S. imports.
However, China failed to uphold its end of the deal, which is why Trump is taking a tougher stance on China now. This escalates the stakes, and the markets’ reactions could be far more intense than during the first round of the trade war.
