Understanding Market Dynamics, Regulatory Changes, and Investment Trends
The election results have already impacted market sentiment and performance. The S&P 500 index experienced a historic post-election performance, rising by 2.5% on the day after the election and hitting new record highs. Despite some ensuing volatility, US markets have continued to reach new records in the weeks that followed. The first-day post-election surge was partly driven by investors’ relief that the electorate had made a decisive decision without the need for protracted debate surrounding the winner. Importantly, expectations of pro-growth policies, including tax cuts and deregulation, improved optimism and have continued to boost markets since then. These new policies are anticipated to also benefit private markets and sectors such as energy, financial services, and certain technology segments (e.g., Gen-AI). In addition, this new policy direction is prompting deal makers to expect IPO and M&A markets to thaw.
However, proposed trade policies by President-elect Trump, particularly when it comes to the use of tariffs, could introduce volatility in markets and have economy-wide repercussions. His proposed 10-20% tariffs across the board, including on European goods, may cause investors to hesitate to invest in European stocks due to the resulting uncertainty. In fact, the DAX index (Germany’s benchmark stock market index) fell by 1.1% the day after the US election and has essentially stayed flat in the weeks thereafter. Many EU countries, Germany in particular, rely on exports as a source of real GDP growth and would be negatively impacted by significant tariffs. Furthermore, imposing significant tariffs can lead to retaliation by trading partners and a retrenchment in global trade.
A potential lowering of the corporate tax rate to 15% for companies whose products are manufactured entirely in the US could also mean further capital flows into the US and away from the EU.
Extending the individual tax provisions of the Tax Cuts and Jobs Act of 2017 (TCJA) would in theory increase US consumers’ disposable income and sustain demand for certain products and services. However, if such policies are accompanied by significant tariffs that lead to higher consumer prices, it is unclear what the net effect would be on consumer spending.
Federal Budget Deficit vs. Debt: Where We Stand?
The lure of increased federal/national government spending to stimulate the economy or certain sectors is strong across the political spectrum, even though spending priorities, whether in defense, infrastructure, health care, education, or social programs, may vary greatly. While high levels of government spending can have a stimulative effect, particularly in the short term, it can also add to the government’s budget deficit. This is particularly problematic for countries that are still grappling with the heavy fiscal burden created by programs implemented in response to COVID-19.
Rising federal government debt is the elephant in the room as the US debt burden is growing at an unsustainable pace. According to the latest analysis by the non-partisan Congressional Budget Office, interest expense on federal debt is expected to reach 3.4% of GDP in 2025, exceeding most other federal budget categories, including defense, Medicare, and Medicaid mandatory spending. This analysis reflects current law, without considering the impact of further fiscal spending promised during the presidential campaign trail.
According to estimates from the Committee for a Responsible Federal Budget, an independent think tank, President-elect Trump’s plan would increase the US federal debt by $7.75 trillion over the next 10 years.1 This includes the impact of extending certain TCJA temporary tax cut provisions that are set to expire in 2025. By some estimates, making those provisions permanent and modifying others within the TCJA would add in excess of $5 trillion over the next 10 years to the national debt. On the other hand, not extending some of the provisions may weigh on consumer spending in the near to medium term, as disposable income would decline for some income echelons.
Promises that higher spending or tax cuts will stimulate the economy creating a fiscal multiplier effect that will offset the deficit impact are not borne out by research or the historical record. Politicians often believe that the increase in economic growth will create tax revenues that will far outweigh the extra fiscal spending, which is not what typically has happened. If investors doubt the credibility of such promises, it can lead to financial market turmoil. The UK experience in 2022 offers a cautionary tale. Shortly after taking office, the government of Prime Minister Liz Truss proposed a significant tax cut, including reductions in top income tax rates, claiming that lowering the top rates would more than pay for themselves by boosting economic growth. Financial markets, already reeling from the economic shock of the war in Ukraine, responded with a massive sell-off of UK government bonds that sent interest rates soaring and the British pound plunging in value. The Truss government quickly backtracked but the damage was done and contributed to her resignation shortly thereafter after just 49 days as Prime Minister—the shortest term in UK history. The recent release of the October 2024 UK budget contemplates further government spending that will need to be financed partially by issuing more debt. While not causing major fears in markets, these new plans have contributed to higher long-term interest rates in the UK. More broadly, the International Monetary Fund (IMF) has been sounding the alarm on the dangers of large fiscal deficits and elevated debt levels, which have been on an upward trajectory across the globe, calling for fiscal prudence.
For businesses, the impact of higher government debt burden is most directly felt in its impact on interest rates. In the US, expectations are that the US Federal Reserve, which had raised interest rates to a 20-year high as it tried to rein in inflation, will make several interest rate cuts in the coming months. However, in the longer term, the unsustainability of a high government debt burden is likely to exert upward pressure on interest rates and debt yields. This can impact virtually all sectors of the economy by raising the cost of capital, pressuring valuations and balance sheets, inhibiting M&A and private equity activity, and leading to delayed or deferred capital investment.
The viability of President-elect Trump’s plans to cut inefficiencies in government and slash costs remains to be seen. While some reports indicate that there could be a massive federal government restructuring, including significant reductions in personnel, the largest budget spending categories are in defense and mandatory programs like Social Security and Medicare/Medicaid – areas where significant cuts are unlikely to occur. As a result, the positive impact on reducing the deficit from such initiatives may be more limited than campaign rhetoric would suggest.
If the US continues down the path of sharply increasing budget deficits, it may well lose its AAA sovereign credit rating by Moody’s, the last of the three major rating agencies to assign the top rating.
Sectors to Watch
Several sectors are poised to be significantly influenced by the Trump administration, particularly under the “America First” agenda. The energy sector, for instance, is expected to benefit from shifting regulatory priorities, especially for fossil fuels, potentially at the expense of renewable energy initiatives. This could slow the transition to sustainable energy sources and lead to tensions with countries prioritizing green energy.
In the financial services sector, the anticipated rollback of certain regulations could drive growth by fostering investment and innovation. Crypto markets are a case in point, with a surge in prices being observed since the US elections. However, this might also elevate the risk of financial instability, especially if oversight is significantly diminished.
The technology sector could face challenges due to potential trade restrictions and tariffs on foreign imports, specially from China, which may disrupt supply chains and increase costs for companies reliant on global sourcing. This could lead to a realignment of tech supply chains and increased competition from non-US firms.
Healthcare is another sector that is likely to see significant changes with the appointment of new leadership. Policy shifts related to healthcare funding and regulation could impact the sector’s stability and growth. The direction of these changes will depend on the administration’s approach to healthcare reform, which could influence the global pharmaceutical and medical device industry, given the US's large share of the market.
Additionally, the expansion of investment vehicles such as Private Credit and Equity ETFs, and the availability of digital currencies as both a medium of exchange and an opportunity for investment, will provide opportunities for both investment managers and investors.
Overall, while the “America First” agenda promoted by the Trump campaign aims to prioritize US interests, it will have broad implications for international trade, regulations, and global market dynamics. Investor due diligence will remain crucial to navigate these changes effectively.
