Election Results and Potential Impact

The Election is over, now what? Malcolm Polley, CFA, Chief Market Strategist for Stratos Investment Management shares his post election commentary as it relates to the economy below.

Former President Donald Trump is now President-elect. The first person since Grover Cleveland to win a split term at the highest office in the land. So, what does that mean for the domestic economy and economic policy? While it is early, and President-elect Trump is still finalizing his administration, here is what we are thinking:

Tax Policy

We believe that the first order of business will be to extend the tax cuts due to expire after 2025. This will include continuing the lower income tax rates established under the Tax Cuts and Jobs Act (TCJA). It should also mean maintaining the higher standard deductions, and that Congress may, at a minimum, maintain the current estate tax exemptions established under the TCJA, potentially indexing them for inflation.

More problematic (at least from a fiscal standpoint) would be getting rid of the cap on the State and Local Tax (SALT) deduction. This primarily impacts high(er) income filers who reside in high tax locales like New York and California as filers are currently limited in how much state and local taxes they can deduct against their federal income tax.

President-Elect Trump has also talked about exempting social security income, tips and overtime pay from income taxes. While they are popular ideas for certain segments of the population, these proposals create a bit of a revenue hole for a federal budget already in significant (and growing) deficit.

Tariffs are the other major tax proposal likely to happen. While he has proposed 60% tariffs on Chinese imports and as much as 20% tariffs on imports from the rest of the world, we believe that the headline number(s) are likely a bargaining chip and that rates (if enacted) may likely be lower.

We believe The dangers from the tariff proposals are two-fold. First, if we assume a 10% tariff on all non-Chinese imports, it is estimated that the core PCE deflator (Personal Consumption Expenditures – The Fed’s preferred inflation gauge) would rise by 0.8%.

Based on current inflation rates, this would increase core inflation to close to 3%. Secondly, and potentially the biggest danger, would be that increasing tariffs globally could kick off a global tariff war that could significantly harm global economic growth as happened prior to the Great Depression with the Smoot-Hawley tariffs. While we view that likelihood as remote, it is something to keep in mind.

Interest Rates

The Federal Reserve began the process of bringing down short-term rates at their September meeting, cutting rates by half a percentage point (50 basis points), and continued the process by cutting an additional quarter percent at its November meeting. We had discussed in a recent piece (Against the Grain: What if the Fed Doesn’t Do As Much?) the potential that the Fed might not need to cut rates as much as their September Dot-Plot indicated. If tariffs get implemented causing the core PCE deflator to rise close to 3%, then the Fed might be forced to stop cutting earlier than they would (seem to) want.

We think that it is instructive to look at the change in the US Treasury yield curve from the end of the third quarter and just prior to the election. As you can see from the yield curves below, while shorter-term rates have moved down, longer-term rates have risen.

While we have been expecting the yield curve to normalize, this scenario has been one of our concerns as we believe higher longer rates have two implications for investors: 1) poor to negative returns for bond investors and 2) the potential that the Fed may feel the need to significantly slow cuts or reverse course. We believe that this could have a continued negative reaction from more than the bond market. This is because as rates rise, the discount rate for equities would rise putting downward pressure on equity values.

The Economy

Equity markets initially cheered the result of the presidential election as the potential for loosening up the regulatory environment could mean increased M&A activity and, in the case of the banking industry, loosen up capital for increased lending. Indeed, if the incoming Trump administration is able to reduce the regulatory burden on businesses it could spur investment across the board. Add to that the potential for

increased scrutiny on government waste and you could see government’s portion of GDP go down as businesses’ increases. That said, the consumer still represents more than two- thirds of economic activity and here is where things could get “interesting”.

President elect Trump’s proposals (outlined above) to exempt tips, overtime pay and Social Security from income tax would certainly give the consumer more income with which to spend. We believe that this has two impacts. First, exempting those sources of income from taxation would widen the federal deficit, increasing the need for the Treasury Department to issue additional debt continuing a crowding out effect that would drive up interest rates. Second, the additional income should increase consumer spending which should increase GDP growth. To the extent that GDP growth rose above its long-term “potential”, it could spur inflation which would ultimately put pressure on the Fed to increase short-term rates.

The Bottom Line?

Ultimately, much of what could happen is dependent on Congress passing the incoming administration’s proposals. While Republicans have gained control of the Senate and (while the jury’s still out on the final outcome) could maintain its hold on the House, passing legislation is often far more difficult than the administration might like. We believe that investors should approach the coming transition as they should any change. Don’t get out over your skis. In other words, don’t start investing without understanding the risks and don’t reach for performance. Hippocrates had it right: First do no harm.

Disclaimer: The information contained in this market commentary reflects the opinions of Stratos Investment Management. These opinions do not reflect the views of others and are subject to change without notice. Content in this material is intended for general information purposes only and should not be construed as specific investment advice or recommendations for any individual. Please contact your advisor with any questions or for specific recommendations regarding your own circumstances. Investing involves risks including possible loss of principal. Stratos Private Wealth is a division through which Stratos Wealth Partners, Ltd. markets wealth management services. Investment advisory services offered through Stratos Wealth Partners, Ltd., a registered investment adviser.  Stratos Wealth Partners and its affiliates do not provide tax, legal, or accounting advice. This material has been prepared for informational purposes only; and is not intended to provide, and should not be relied on for, tax, legal, or accounting advice. You should consult your own tax, legal, and accounting advisors before engaging in any transaction. Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual.  To determine which strategies or investments may be suitable for you, consult the appropriate qualified professional prior to making a decision.  Investing involves risk including possible loss of principal. Some of the information contained herein has been obtained from third party sources which are reasonably believed to be reliable, but we cannot guarantee its accuracy or completeness. The information should not be regarded as a complete analysis of the subjects discussed