Digesting the election and investment implications

It has now been just over two weeks since Donald Trump swept to a 312 to 226 victory in the electoral college, setting him up for another four-year term as President of the United States. In that short time, both Trump’s supporters and detractors have been provided plenty of evidence that they were “right” in their assessment of Trump and the outcome of a second term. For his supporters, he has nominated seasoned administrators to oversee his immigration policies, raising the prospect that the new administration will effectively marshal resources to deport potentially hundreds of thousands of immigrants whose original crossing into the United States was illegal. His trade nominees suggest he intends to follow through on tough tariffs on Chinese goods and on imports generally. On foreign relations, Marco Rubio as Secretary of State does not appear likely to set off alarm bells internationally, and Elise Stefanik may be seen as a necessary tough voice as Ambassador to the United Nations. Ad in a move that may be of great consequence or none, Trump announced the appointment of Elon Musk and Vivek Ramaswamy to a Department of Government Efficiency (“DOGE”) assigned the job of rooting out inefficiency and unnecessary regulations with a goal of $2 trillion.

But Trump has certainly given his critics and doubters ample ammunition as well. For one, the pick of Matt Gaetz to be Attorney General appeared almost non-serious. He was a gadfly congressman with little legal experience who precipitated the crisis that brought down his own party’s Speaker of the House and was still under investigation by the House Ethics Committee for possible sexual misconduct and illegal drug use. Gaetz resigned from the House of Representatives the day after his nomination was announced, a highly unusual step that appeared to be designed to head off release of the House committee report expected two days later. But Gaetz’s nomination immediately put less “MAGA” members of the United States Senate under the spotlight, particularly the new majority leader John Thune from South Dakota, Susan Collins from Maine, and Lisa Murkowski from Alaska. Many speculated that the Senate would cave to Trump’s demands and allow a demonstrably unqualified nominee to assume office either through an affirmative vote or allowing a recess appointment. But, as of this afternoon, Gaetz withdrew his name, and the Senate has put down an early marker that there are some limits to their willingness to go along with Trump’s demands. 

Economically, Trump will have a majority in the House and Senate, and so some form of extension of the 2017 Tax Cuts and Jobs Act is going to be approved. What it will look like is difficult to imagine. The approval of the 2017 bill required that Republicans first agree on a maximum amount of additional deficit they were prepared to create during the 10-year measurement period that is used for bills that are considered under reconciliation. With the Biden administration desperately trying to push money out the door (lest it be pulled back and used to offset Republican priorities like reducing the corporate income tax even further), the Trump administration has a difficult needle to thread. With the annual deficit already approaching $2 trillion (revenues are only roughly $5 trillion, expenses $7 trillion), what will the appetite of both Congress and the bond market be for deficit spending above the trajectory we are already on? As one considers this question, it is important to remember that interest on the national debt is now over $1 trillion annually, more than the entire defense budget, and so any action that spooks the bond market and increases interest rates puts additional pressure on the budget via higher aggregate interest expense. 

So, as much as the political stars have aligned to enable Trump to enact his agenda, the fiscal stars may be far less favorable. The deficit is part one of what is a two-part problem for Trump, and inflation is the other, related, issue. Deporting hundreds of thousands of immigrants who perform lower-wage jobs, imposing tariffs on imported goods and reshoring industrial and technology products away from China will raise the costs of goods and services for Americans. However, as we have seen, the Federal Reserve is ever watchful, inspecting the data each month to make sure there are no signs of inflation reigniting before lowering interest rates further. If inflation begins to rekindle for any reason, related to Trump’s policies or not, the yield curve will steepen, and the Federal Reserve will pause any further rate cuts and might even have to consider an increase. Either action will slow the economy and frustrate Trump, creating almost unimaginable tension between Trump and Jerome Powell, chair of the Federal Reserve.

So, this is the needle that the Trump administration and the Republican congress must thread. Can deregulation, lower taxes, more favorable energy policy and pulling back on various Biden spending initiatives provide enough downward pressure on prices to offset the impacts of other Trump policies “ceteris paribus.”   It is those last two words that are the other crucial factor in politics. Ceteris paribus means “all other things being equal”. But of course, all other things are never equal, and forces way beyond the administration’s control can arise at any time and upset the best laid plans – or land the administration in clover despite having played no role in a desired outcome. As much as investors and analysts would like to analyze the factors and assign proper weights, there will be new external factors that cannot be accounted for today. In fact, a lot will be up to chance.

We are at a volatile moment. We had 8 years of a progressive Obama Administration, followed by a sharp rightward turn, then a pandemic, then an even sharper leftward turn and now what may prove to be an even sharper still turn to the right – by an administration that understands some of its missteps in enacting its agenda last time and does not intend to make those mistakes again. Against this backdrop, the equity market remains bifurcated with a series of platform businesses driven by tremendous technological innovation making outsized profits and being rewarded with eye-popping multiples, thereby resulting in market capitalizations in the hundreds of billions to trillions. Meanwhile, thousands of other businesses plod along with less robust growth and price earnings multiples, but in many cases earning respectable returns on equity. Investors who have not shifted their allocation to move 50% or more of their equity portfolio into technology-related names have been left behind – although many have still earned 15-20% returns in the process for 2024 year to date. Whether those technology-related names deserve their exalted multiples remains the question all investors must confront. At Spinnaker, we believe profoundly in the power of technology to make our lives more efficient, more connected, and more enjoyable, and we watch every day as ordinary citizens and businesses shift their spending toward technology companies to capture these benefits. However, we recognize that the stock prices of leading companies are in many cases discounting profits many years in the future back to the present, so changes in the 10-year US Treasury rate could have a dramatic impact on the valuation of equities – and in particular the valuations of the most expensively priced equities. So, our focus in many respects is on the 10-year US Treasury and how the Trump administration and the new Republican Congress thread the needle to enact their agenda without precipitating further inflation.

Spinnaker continuously reviews clients’ asset allocation, ensuring that the runup in equity values has not tilted their overall allocation to equities beyond the limits of their comfort zone. We are now recommending that client portfolios reduce their allocations to international equities slightly. Democracy is, unfortunately, not on the march around the world, and while we are concerned about many issues in the United States, we are hesitant to swap for the prospects of most other nations. The one other place where a substantial number of world class companies are emerging is China, but that comes with its own set of concerns that require careful limits on exposure no matter how impressive the individual company may be.

Your service team would be pleased to review all these issues with you, along with steps that may be advisable, or in some cases no longer necessary, for year-end tax planning. We wish all our clients a safe and happy holiday season with family and friends.