Trump and the Markets

"I do not know much about the tariff, but I know this much: when we buy manufactured goods abroad, we get the goods and the foreigner gets the money. When we buy the manufactured goods at home, we get both the goods and the money." 

– Abraham Lincoln

Now that we are off into the New Year and the beginning phases of the next presidential administration, we thought now is a better time than ever to give you an update on the current economic landscape, and how it might impact your investment portfolio. As the policies of the new administration take shape, we’re observing significant shifts in policy and market dynamics that could influence your financial plan. In this update, we will explore inflation and the Federal Reserve’s recent decision to cut interest rates, the rise in Treasury yields, as well as Trump’s economic policies. We will also discuss how these developments are shaping market trends and go into some of the bright spots and challenges we will see in the coming months and year. Many of you have feelings of either fear or excitement, but regardless of where you stand politically, the end goal is to improve your financial well-being and to be informed of the current issues and markets. Let’s begin with a look at the Federal Reserve’s latest actions and the reactions we have seen in the bond market.

Federal Reserve Policy

Inflation has been one of the biggest drivers of market volatility in recent years. As you may recall, inflation measured by the CPI (consumer price index) peaked at 9.1% in June 2022. It then had a steady decline until September 2024 when it bottoms at 2.4%.i While the rate of inflation has been decreasing, it is still above the Fed target of 2%. The latest CPI report for December came in above the target rate of 2% at 3.2%. While this may seem high, it was below market expectations and has been mostly positive news for the overall market.ii The declining rate of inflation has provided enough evidence for the Federal Reserve to begin cutting interest rates even though inflation hasn’t reached its 2% target. At the last Fed meeting, the Federal Funds rate was cut a quarter point and has now been reduced for a total of 1%.iii This brings the federal funds rate to a range of 4.25%-4.5%.

Bond Market Reaction

The Fed rate cuts come at a time when the bond market has seen a paradoxical rise in 10-year treasury yields, which have now climbed to 4.7%. Simply put, the Fed has cut the federal funds rate around 1% while the 10-year treasury yield has increased 1%. With inflation still above target, investors in the bond market are demanding a higher yield for long term bonds anticipating that inflation will remain higher. One of the indicators that inflation will remain high is the employment levels as the December jobs report came in much higher than expected in late 2024 with a burst of hiring to finish the year.

10-Year Treasury Yield in Blue 

Federal Funds Rate in Red

The bond market is calling into question the credibility of the Federal Reserve. Why does Fed credibility matter? The Fed’s monetary policy works largely through market expectations. When the Fed says it will do something, markets need to believe it for it’s monetary policies to be effective. When the Fed cuts rates, it’s trying to make borrowing cheaper throughout the economy. But if markets don’t believe in the Fed’s economic assessment or policy decisions, they can push back through higher long-term rates, essentially canceling out the Fed’s intended effects. This is exactly what we’re seeing now. The unusual rise in Treasury yields despite Fed rate cuts suggests the bond market fundamentally disagree with the Fed’s view of the economy, making their policy tools less effective at a time when they might need them most.

Trump Tariffs

With Trump’s return to the presidency, several economic implications are anticipated. The economic landscape is visibly being reshaped by Trump’s aggressive tariff policies, which have been a focal point of his campaign and the early days of his presidency. On day 1, he announced plans for imposing a 25% tariff on goods from Canada and Mexico, alongside a 10% tariff on imports from China.v These proposals have been met with criticism from his opponents as well as from the countries in which tariffs are targeted. It should be noted however, that the market reaction to these threats has been rather muted with minimal downside reaction by the stocks who would be most greatly impacted. To me, this indicates the reason for the threat of tariffs is greater than just economic protectionism, but rather a tool he uses to negotiate better trade deals. It is no longer 2016, we have been down this road before, and the market has a reasonable idea of what to expect.

Tax Policy

As part of President Donald Trump's economic agenda for his new term, several tax proposals have been put forward or hinted at during the campaign and early days of his administration. The most likely change we will see in his administration is the extension of the Tax Cuts and Jobs Act, which he passed in his first time 2017, and has an expiration date of the end of 2025. January 2025 will look to make permanent most of the individual tax cuts. As you may recall, these tax cuts extended lower tax brackets, doubled the standard deduction, and increased the estate tax exemption. On the corporate front, there have been indications that the corporate tax rate could be reduced to 15% for companies who manufacture in the United States, creating an incentive to repatriate and produce domestically. One of the big items of the campaign was the “no taxes on tips” mantra. It has been accompanied by claims of getting rid of taxes on social security benefits and overtime pay. It remains to be seen if any of these tax cuts will happen but if they do, the revenue will need to be made up somewhere else. That Most likely be through tariffs. Overall, his tax policies will be oriented toward growth, which is positive, but the unintended consequences of tariffs do pose a threat.

Market Dynamics

There is a lot of bullish indicators in the overall economy right now. Inflation is trending lower, employment remains strong, the Fed is easing monetary policy, taxes are most likely headed lower, and earnings growth in the S&P 500 has been resilient. So, what could go wrong? One of the phenomenon’s we are currently witnessing is the ever-increasing concentration within the S&P 500 amongst the top 10 stocks by market cap. The 10 largest stocks now account for over 35% of the total market cap! This type of concentration at the top amongst large cap stocks hasn’t been seen in more than 30 years significantly reliance on the few mega cap tech names to drive the index higher. The disparity has been stark when you look across the board within the index. With so few names carrying the index, the number of stocks underperforming the overall index is greater than the ones outperforming. This had led to many investors to move from buying individual stocks to buying index funds instead. Here at Carlson Asset Management, we have been doing that as well, but in a way that is mindful of the current top- heavy weighting. 

Within the S&P 500, we are currently favoring an equal-weight approach when buying an index fund. On top of that, sectors that have underperformed relative to the S&P 500 over the past couple of years like healthcare, industrials, materials, and energy are looking favorable on a going forward basis. There are individual names and exchange traded funds we like within these sectors that offer tremendous value right now.January 2025

Bitcoin

The bond markets expectation of higher inflation has also shown up in the prices of Bitcoin. It has done very well over the last year and in recent weeks. To me, the price increase is telling investors inflation is entrenched and that the US debt will likely continue to grow. Trump is the first president we have had that has a positive policy platform as it pertains to cryptocurrencies, and I expect his administration to offer greater legal clarity with proposed executive orders and legislation. There have been rumors he is exploring the creation of a Strategic Bitcoin Reserve for the US government, similar to Fort Knox with Gold. We are still in the early days of Bitcoin despite the price now hovering around $100,000. It is always a fun asset to track as it trades 24/7/365 with no circuit breakers or other market manipulation, it truly is a free market. We do allow for limited investment for risk tolerant accounts if you are interested.

Summary

In the coming months, we may experience some volatility especially if the bond market continues to respond to the federal reserve the way it has. We also could expect some bumps in the road due to tariffs and other policies from the administration. But despite all that, our outlook overall for the year is positive. We will continue to look for opportunities in areas where we see opportunity while also being mindful of risk and your overall financial plan. In the coming weeks, tax documents will be sent out from our home office. If you have any questions or would like to do a review, please call our office.

Sincerely,

Bruce Carlson, CFP®

President

Carlson Asset Management
 

The opinions expressed in this commentary are those of the author and may not necessarily reflect those held by Kestra IS or Kestra AS. The material is for informational purposes only. It represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. It is not guaranteed by Kestra IS or Kestra AS for accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions. It should also not be construed as advice meeting the particular investment needs of any investor. Neither the information presented nor any opinion expressed constitutes a solicitation for the purchase or sale of any security.