The growing likelihood that Donald Trump will be the next US President, and possibly in control of both houses of Congress, should prompt investors to review their investment strategy. While currently both equity and bond markets appear relaxed at the prospect of the second Trump presidency that almost certainly won’t be the case when he is in office. My view on Trump’s potential to disrupt the current market exuberance is based on his limited number of policy statements and US media reports on post-election plans being developed by Trump’s team of policy advisors.
Key Trump policies likely to have unexpected consequences for shares and bonds are his plans to develop a de facto veto right over Federal Reserve interest rate decisions, plans to extend or increase tax cuts for the wealthy and the potential increase in the size of US deficits, and plans to raise tariffs to 10% on all imports and up to 100% on most Chinese imports. Back in 2018 Trump declared: “Trade wars are good, and easy to win.”
On the Federal Reserve, Trump was during his first term itching to take control of interest rates by appointing a Trump stooge to the key interest rate setting committee. He was unable to rig The Fed during his first term as President because the Democrats controlled the Senate and were able to head him off at the Pass. (The President nominates Fed governors, but they must be ratified by the Senate).
If Trump becomes President he only needs to win one additional Senate seat this November and (as the Republican Party generally does whatever Trump commands) he can appoint as many Fed governors as he likes.
Bond markets should tremble at the prospect of a Federal Reserve that aims to keep interest rates low and shirk its duty to keep inflation under control. If markets feel that the Fed is going soft on inflation that would trigger the mother of all bond market routs. A rise in US Government 10-year bond yields from 4.5% currently to 6% (not out of the question in a meltdown) would wipe out large chunks of the shareholders’ funds of major US banks. The pension funds that underwrite the retirement incomes of America’s middle classes would also take a belting.
During his last term in office Trump passed the Tax Cuts and Jobs Act, which cut the US company tax rate from 35% to 21% and granted very favourable income tax cuts that mostly favoured the wealthy and higher income earners. The Brookings Institute recently estimated that Trump’s tax cuts would swell the US Federal Deficit by US$2 trillion by 2028. Recently Trump has indicated that he would extend the tax cuts for the wealthy (which expire in 2025) if he is elected this year. If Trump did that the projected US budget deficit for FY2026 would increase from around US$2 trillion to around US$3 trillion, or more than 9% of GDP.
The level on new bond issuance to fund this exercise in fiscal recklessness would exceed anything attempted by a major economy ever. Thus, Trump’s plan to grease the palms of the rich is based on borrowing money at a pace never seen before, with hopes and prayers that the traditional buyers of US paper (Japanese, Chinese and European banks and pension funds) don’t demand a higher yield.
Of course, students of Trump’s business history knows that his central business strategy has been to borrow big, declare bankruptcy, and move on. (Trump has presided over four major Chapter 11 corporate bankruptcies that he admits to. Some US fact checkers reckon he has presided over six corporate bankruptcies). The bottom line: Trump’s tax cut plan relies on the kindness of strangers. If his plan is implemented, the risk of a gap up in long term bond rates increases.
The third leg of Trump’s economic strategy – raising tariffs to protect US industry – is also guaranteed to put further upward pressure on rates. Trump’s liking for tariffs is driven by his ego-driven desire for big wins (tariffs are easy to implement and he can boast of beating up nasty foreigners) and the fact that he earns adulation from fellow billionaires whose profit margins are boosted (albeit temporarily) by tariffs. Trumps has suggested an overall 10% tariff on all imports and a 60%-100% tariff on all Chinese imports. While this policy has widespread appeal in rust-belt states which had been battered by the hollowing out of US manufacturing, the practical implications for the US economy as a whole are deeply troubling. The idea that imposing tariffs would boost US manufacturing is a joke. Trump’s tariffs simply allowed US manufacturers to increase consumer prices. A university of Chicago study found that US washing machine prices increased by $86 per unit after tariffs were imposed. Every new job created in the industry (about 2000) cost consumers about US$800,000 to subsidize. The washing machine example showed that tariffs are highly inflationary. And inflation is the enemy of bond and equity markets.
When Trump was first elected many trading partners with the United States copped his tariff increases on the chin and put up token resistance. The second time around America’s trade partners are more likely to respond with tit-for-tat restrictions on US exports.
But perhaps the easiest way for China to punish America for huge tariff increases would be to begin selling some of its massive holdings in US Treasury bonds. China doesn’t need to hold the US$800 billion in US Treasuries it currently does. If China decided to exit its US bond position in a swift manner there would be carnage in bond markets.
In summary, Trump’s stated policies represent a real and present threat to global bond market stability. And a plunge in bond markets would likely send equities into a major correction also. In short, there is no silver lining in Trump for investors. Of course, there is no guarantee that Trump will enact his policies in his current form. Trump is famous for U-turns without explanation other than his manifest genius.
For investors there is no sure and safe way to insure against the worst outcomes of a Trump presidency. However, there are a few simple techniques that might limit damage to your wealth. For those with borrowings it might be smarter to refinance today with a longer maturity than to pray that debt markets will be favourable in 2025 and 2026. For equity investors there is no protection other than minimising exposure to momentum stocks on impossibly high price-earnings multiples and companies that have major refinancings due in 2025 and 2026. Anyone with an equity exposure of greater than 60% might consider going for a more conservate level (tax permitting) of, say, 40-45%. For bond investors the best advice is to sacrifice yield in the name of capital preservation and chase out quality names (AA rated or better) with 2–4-year maturities. Those who want an added layer of protection should consider some kind of exposure to gold, either an ETF or a major producer with long mine lives.
There is an old Chinese curse that says: “May you live in interesting times”. With the prospect of a Trump Presidency we are now living in interesting times. Your portfolio should be ready for it.
