Trump, again

With the second Trump administration now a month old (not a short month!), I’m devoting this special issue to the new president’s plan of action and the implications for the markets.  

History: For analogy to the present day, one must look to the nineteenth century. Trump’s House majority is the smallest since the Civil War, and popular support has flipped between the parties in nine of the last 10 federal elections, a level of upheaval not seen since the years 1878-96. Perhaps it’s no surprise, then, that Trump should take inspiration from President William McKinley, who was elected in 1897 and embraced tariffs. Trump also bears a political resemblance to the “speak softly and carry a big stick” approach of McKinley’s successor, Teddy Roosevelt. 

Market: The S&P 500 has posted gains in nine of the last 10 first years of presidential terms, and of the four years in a term, the first year is the best on average. A recession could change that calculation, and it often has, with Trump 1.0 being the first Republican president since Warren Harding to avoid a first-year recession when taking over from a Democrat. The recent enthusiasm for fiscal discipline, however, could moderate the burst of liquidity from new presidents’ initiatives that have lifted year-one returns in the past. Financials have outperformed the S&P 500 in the first year of a president’s term 12 of the last 13 times. Health Care has been the next-best sector, having outperformed the market in the first year of every GOP administration since that of President Ronald Reagan. Oil and gas producers look to be a market segment that could benefit from Trump policies. Investor Stanley Druckenmiller expects animal spirits to appear, saying that we have gone from “the most anti-business administration” he’s seen in his career to the opposite. 

Trade: Tariffs used to be so normal. At the dawn of the republic, pretty much the entire federal budget was funded by tariffs. The first significant law passed by the first Congress back in 1789 was a tariff act. Over time, dependence on tariffs decreased but remained substantial. The enactment of an income tax in 1913 was a big step away from tariffs. Stephen Miran, whom Trump has tapped to chair his Council of Economic Advisers, says 20% would be an optimal tariff rate; the current rate is just 2%. One advantage of tariffs is their ability to raise money without passing a tax hike. The other advantage is their potential as a lever to influence policy. These purposes are in conflict, however, and it will be interesting to see which we want more: the money or the influence. One key area to watch will be Asia. If Trump wants to distance the US and its trading partners from China, will he play hardball with India, Vietnam, etc., or will he be willing to accept token concessions from them? And will Trump crack down on Chinese efforts to evade tariffs by routing production via Vietnam, Mexico and elsewhere? Of note: Mexican President Claudia Sheinbaum moved in January to restrict the flow of goods from China into her country so as to allay US concerns about this very matter. The United States-Mexico-Canada Agreement (USMCA) is due to be renegotiated next year. If Trump convinces himself that the policy gains are worth higher inflation, he risks voters’ ire. Incumbents lost 26 of 32 elections globally last year, and more than half a billion votes were cast for populists. It’s possible, though, that due to strong productivity growth the Trump tariffs’ impact on US inflation will be reduced.

DOGE: The GOP has a majority but it is razor-thin and the Trump agenda so far (DOGE especially) has been unifying to the Democrats while posing some challenges for Republicans. For instance, the overseas aid programs DOGE has been cutting distribute a lot of food grown by US farmers; if that outlet disappears, farmers (many of them in GOP states) will be upset. The Congress faces a government shutdown by March 14 and a debt ceiling limit this summer. The House and Senate have not agreed on an approach, and reconciliation will require time and planning. DOGE will not, on its own, significantly reduce the deficit. Half of all government spending goes to Social Security and health care. Another 11% goes to pay interest on the debt. So, it’s really the other two-fifths of spending that’s currently up for debate. 

Geopolitics: Trump’s approach is consistent with the Monroe Doctrine. Not only is he America-first, but he also wants to ensure no other power holds sway in this hemisphere: thus his concern about the Panama Canal and his enthusiasm for Greenland. It seems clear, too, that he will insist that Mexico not cozy up to China and that Canada provide continued access to natural resources. Thus, too, his insistence that Europe pay more for its defense; for Trump, the importance of the alliance with Europe is less self-evident than for his predecessors. The Europeans may respond by increasing their military spending and shoring up their access to energy and other natural resources. China seems to be Trump’s main concern, strategically. In 1995, China accounted for just 5% of global manufacturing. Today, that figure is 32%, more than twice the US share. It’s hard to imagine the tariffs with China have reached their peak. Back in the 1990s, China and Russia still nursed old grudges towards each other, and the US was interested in working with both countries. Russia now conducts more than half its trade in yuan. Also, does the widening spread between US and Chinese bond yields mean that China is weakening—or does it just mean that investors from China and elsewhere see less reason to continue to hold Treasuries? 

Immigration: Trump is reported to have said that the issues that got him elected are immigration and inflation, in that order. Mass deportations seem unlikely for a host of reasons, one of which is cost. I have seen estimates from $300-$900 billion to deport 13 million people. It would be simpler for the administration to cancel discretionary visa programs affecting about three million people. If so, the labor market may see its greatest impact in Q2 and Q3 of this year. 

The Future: Trump’s Stargate AI program could lead to billions of new AI infrastructure spending. SoftBank and others will spend $100 billion on AI infrastructure for now, with the goal of raising an additional $400 billion over the next four years. This is in addition to the billions and billions that US companies already spend on data centers and AI infrastructure annually. Thanks in part to the presidential imprimatur, Stargate may give an organizing “arms race” concept to AI competition between the US and China. US companies, and particularly the Magnificent Seven, have not waited for the government to take the lead. Goldman Sachs calculates the growth investment ratio as the combined total of growth-oriented capex (less depreciation) together with research and development all taken as a share of cash flow from operations. The most recent figures show growth investment for the Magnificent Seven at 56% versus 36% for the rest of the S&P 500 (and 26% for the rest of the world). In other words, American exceptionalism led by the Mag 7 may continue.