To my clients:
It was an up week for North American stock markets with the Canadian TSX finishing up 2.1%; the U.S. Dow Jones Index up 4.6%; and the U.S. S&P 500 up 4.7%.
Despite a 0.25% Fed rate cut and a key economic release (the ISM Services Index handily beat expectations hitting its highest level in two years), it should be no surprise what leads and dominates this week’s update – the victory of Donald Trump in this week’s U.S. Presidential election (as well as the accompanying Republican majority gained in the U.S. Senate and the likelihood of the same in the House of Representatives).
As most are probably aware, markets surged this week after Donald Trump won this past Tuesday evening’s election. The question is, why? and what does this portend for markets in the short, medium and long-term? What also does it also portend for portfolio strategy over the next four years?
Whatever one’s views of President-elect Trump, in aggregate his policies will be stimulative to “nominal” GDP growth over at least the first half of his upcoming 4-year term. Here I should emphasize that, in economic-speak, “nominal” means before the deleterious effects of inflation are factored in. I will get to the likely impacts of inflation later in this week’s missive but, for now, let’s take a look at what might spur the anticipated surge in nominal GDP growth…
Key among Trump’s proposed policies is the continuation, and possible further lowering, of the reduced corporate tax rate he enacted in his first term. Taxes that companies don’t pay go directly to earnings and the benefit of shareholders. This alone could explain a major portion of market gains this week. Also important will be the lesser regulation imposed on corporations. The costs associated with navigating often onerous regulatory hurdles are significant. Such costs might be viewed as a de facto tax on corporate America. As with actual corporate taxes, reducing the regulatory de facto tax will also accrue directly to the benefit of shareholders. Trump’s ability to follow-through on both of these objectives will be near certain if Republicans gain control of the U.S House of Representatives – and here the present tally stands at 211 seats for the Republicans and 199 for the Democrats. 218 seats are required for a majority in the House. 25 seats remain undecided, and the Democrats will need to win 19 of these 25 seats to prevent a Republican sweep of Congress (Congress consisting of the Senate and the House of Representatives) and the Presidency. Democrats winning 76% of remaining House seats in an election where Donald Trump won the popular vote by about 3.5 million votes seems unlikely.
Two other key planks of Trump’s platform include 1) a strict clamp on illegal immigration and the deportation of already resident illegal immigrants; and 2) the threat of substantial tariff increases. On the former, many illegal immigrants occupy lower rungs of the labor ladder, often performing jobs many non-immigrants simply don’t want to do. It’s too early to tell how a significant reduction in this segment of the labor force might impact the economy, although I suspect this will act as a brake upon the more growth friendly initiatives cited in the paragraph immediately above. It’s a somewhat similar story on tariffs insofar as it remains an open question as to how much Trump will follow-through on his bluster (he WILL follow through, it’s just a question of degree), as well as how much his tariffs will target specific companies as opposed to countries in general. Regardless, this too will act as a brake on the growthier initiatives previously outlined. In particular, higher costs imposed by tariffs will almost certainly be passed along to consumers and this will put upward pressure on inflation.
Tariffs and their inflationary impact will take time to be realized. In the meantime, covid-inspired inflation continues to diminish back to pre-covid norms allowing the U.S. Federal Reserve to continue its rate reduction cycle with an another 0.25% decrease this week. However, whereas before the end point of this cutting cycle might have been expected to hover somewhere around 3%, its likely that Trump’s policies might now see that end point come in closer to 4% (with this week’s cuts, overnight rates now stand at around 4.75%).
It should be evident from the above that there are a lot of variables likely to play out over the coming years but, in the short to medium term these variables are likely to favour nominal economic growth and, for that matter, real (after inflation) economic growth also. Longer term I strongly suspect the calculus diminishes – not necessarily to recessionary levels, but certainly not at the rosy levels that many are anticipating in the first year or two of Trump’s presidency.
On portfolio management, I anticipate riding the anticipatory pro-growth wave at least through inauguration in January, and likely somewhat beyond. But it seems to me that prudence might require a more cautious approach as time plays out and I would expect that I may begin dialing back equity (i.e. stock) exposure in client portfolios sometime later in 2025. This is especially the case after the two very strong years we have seen for discretionary returns in 2023 and YTD in 2024. The degree to which I might dial back equity exposure remains to be determined, and likely will be in reciprocal sympathy with how aggressively Trump follows through on his more inflationary proposals like tariffs. One of the indicators I’ll be watching is the degree to which margin debt might ramp up (“margin” debt represents borrowings investors can take against the value of their investment portfolio). The ratio of margin debt to portfolio value tends to reach relative highs when so-called “animal spirits” (aka: irrational exuberance... aka: unbridled optimism) peak.
Last unrelated comment: on strong price appreciation, United Healthcare, a long-term (for many clients over 10 years) holding, was sold from discretionary client portfolios this morning. With the stock price moving well above our analyst’s target, my portfolio management discipline forced me to reluctantly enact this trade on behalf of clients. This position has been a stellar compounder of wealth for clients, and I would not hesitate to go back in the name if there is a material pullback in the share price.
That’s it for this week. All the best,
Nick
Nick Scholte, CIM, FCSI
Senior Portfolio Manager
Scholte Wealth Management
RBC Dominion Securities Inc. │ Tel: 604.257.7569 │ Fax: 604.235.9950
3200-1055 West Georgia │ Vancouver, BC │ V6E 3P3
Toll Free: 1.844.665.9900 │Email: nick.scholte@rbc.com
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