When I was a little boy, I went through a phase where it was great fun to build something with my toys and then smash them. Sometimes I imagined I was Godzilla. Whatever I thought I was, it was the destruction that was great fun.
This January our national government will have an almost complete turnover of power from one party to the other. Let’s see what most likely stays the same, what changes and what might get smashed.
What Stays The Same
“The chief business of the American people is business...” Calvin Coolidge. It’s interesting that he said that in January of 1925, 100 years before our new government gets inaugurated.
Mr. Coolidge’s statement was true for over a century before he said it and has remained true for the century since. I do not expect that to change, and this is the most important point for us as investors. When we invest, especially in stocks, the most important thing is whether those companies can be expected to make money in the coming years. And the stock market as a whole is the profit-making part of the US economy. I have said to more than one worried client over the years, “If you think that the US economy is done, never going to grow again, then you should not invest in the stock market. But if you believe that the American economy is not done growing, then you should be invested in stocks.”
Policies out of Washington can affect the growth rate of the economy and which parts of the economy prosper and which do not, but it’s important not to forget that this is a free market economy. Even though it is regulated, it largely runs on its own. Administrations get credit or blame for how it goes, but mostly their impact is at the edges. The beating heart of the American economy is the drive to make money. That has not changed since our founding, and it is unlikely to change in the foreseeable future.
What Changes
In Trump’s first term he showed that he has no regard for convention. That also has not changed. Very shortly after the election he said that one of the most important things was, “Promises made, promised kept.” So, it’s fair to assume that at least some of those promises will be kept. Based on his statements regarding economic policy, it’s clear that his #1 priority is to implement more tariffs.
More tariffs are likely to discourage international trade. This explains why we saw a big jump in small cap stocks right after the election. Small caps have much less exposure to international markets than mega caps, which typically tend to be multinational corporations. Since a lot of tariff policy is directly in the hands of the president, it seems likely that this particular advantage will remain with small caps for the next few years.
Tariffs also have the effect of raising the cost of imported goods. They are a tax on imported goods. Foreign companies don’t just pay that tax, they also raise the price to account for the tax. Think of sales taxes. Our custom in America is to charge whatever the price is and then add the sales tax on top. Sales taxes raise the cost of whatever you buy, and tariffs raise the cost further for anything we import that is subject to those tariffs.
This means that tariffs may cause the rate of inflation to rise. Let’s look at an example. Suppose that the Trump administration enacts tariffs on all foreign made automobiles. The dealers would then be forced to raise the prices on these cars accordingly. And if the competition raises their prices, it opens the door for you to do the same. So American manufacturers might also raise the price on their cars, pocketing the extra profit. And the result is that the cost of new cars goes up, impacting the overall rate of inflation.
It may not play out exactly that way, but adding a tax to the cost of imported goods creates upward pressure on prices.
Over the last two years, the rate of inflation has plunged, largely due to a drop in the cost of goods. As pandemic bottlenecks of supply chains cleared, the added costs created by those bottlenecks went away. In many cases prices stopped going up and in a few they actually declined.
But that’s not the case with services. The cost of providing services is mostly the cost of the labor. The US economy has been dealing with a labor shortage for several years now. Downward pressure on wages is unlikely unless we have a recession. That makes it very hard to get the cost of services down.
Here at the end of the Biden administration the decline in the rate of inflation has fallen to a level that reflects the above – the rate of inflation for goods has declined to near zero or in some cases negative – while the cost of services continues to rise at a relatively slow pace.
Because of this success in largely defeating inflation, the Federal Reserve recently began lowering interest rates. But if tariffs result in reinflating the cost of goods, the Fed may pause, or even reverse the recent declines in rates.
It’s not written in stone that if you raise tariffs inflation is the result. But raising taxes on imported goods definitely creates upward pressure on prices. Whether the administration will have some additional measures to combat that remains to be seen.
The first Trump administration passed a tax cut in 2017 that expires at the end of 2025. Expect that to be extended and based on campaign statements, it’s very likely that the corporate tax rate will be reduced further at that time. Based on this likelihood the Congressional Budget Office has projected that deficits are likely to grow during Trump’s second administration. If this proves to be the case our national debt could also start to have an impact on interest rates. Simply put, the US must sell $2 trillion a year in bonds. If that amount increases, it’s simple supply and demand. The increase in the supply of bonds makes it probable they will have to be sold at lower prices. Lower prices for bonds mean higher interest rates.
Higher interest rates might not make much difference. After all, our economy has continued to grow quite nicely during the recent period of higher interest rates. But it does make it more difficult to buy high priced items like houses and new cars.
But, before getting too carried away with forecasting, I’m always reminded that forecasting is very difficult, especially when it pertains to the future. The above changes may not even happen and if they do happen, they may not happen the way I have imagined. And really, that’s what I expect – that if they happen, they will happen differently than I have imagined – because no one can tell the future.
So what’s the best way to deal with all the changes that seem to be coming down the road? Now is a very good time to review your investment goals and make sure your investments align with those goals. There is no success that I have ever heard of in arranging your investments based on political outcomes. Stay focused on the business of America (which is business!) and on your investment goals.
There’s more. A lot more. We’ll be getting into that next month.
Hal Masover is a Chartered Retirement Planning Counselor and a registered representative. His firm, Investment Insights, LLC is at 508 N 2nd Street, Suite 203, Fairfield, IA 52556. Securities offered through, Cambridge Investment Research, Inc, a Broker/Dealer, Member FINRA/SIPC. Investment Advisor Representative, Cambridge Investment Research Advisors, Inc., a Registered Investment Advisor. Investment Insights, LLC and Cambridge are not affiliated.
Comments and questions can be sent to hal@getyourinsight.com. These are the opinions of Hal Masover and not necessarily those of Cambridge, are for informational purposes only, and should not be construed or acted upon as individualized investment advice. Investing involves risk. Depending on the types of investments, there may be varying degrees of risk. Investors should be prepared to bear loss, including total loss of principal. Past performance is no guarantee of future results.