The US stock market has cheered Trump’s election, especially small and mid-cap stocks. But if he fully implements his policies the economy faces Disruption, higher Inflation, weak Productivity growth and a slowdown, potentially a recession. DIP for short. It may be wise to be cautious on US stocks given the already high valuations for large stocks.
Disruption because tariffs will shift around relative prices and force companies to rethink their supply chains. Disruption also because immigrant deportation policies will leave many industries struggling to find labour, including leisure and hospitality, agriculture, food processing and construction. Further, Trump’s ‘Tudor court’ style of governing as well as some of the mavericks he is appointing to cabinet positions (subject to Senate approval) point to sudden shifts in regulations and markets for some companies and markets.
Inflation because tariffs are expected to cause a one-off rise in the price level of 1-3%, if fully enacted (60% on China and 20% on the rest of the world). Most analysts think he is unlikely to go this far but don’t bet on it. He may impose such tariffs and then start negotiating exceptions and bilateral deals. That way you get disruption and inflation. It would be better if he used tariffs only as threats to get his deals – then there would be disruption but less inflation.
Deporting a significant section of the labour force will also tend to raise wage growth. The longer-term inflation risk comes from a likely expansion of the budget deficit (due to income tax cuts) with rising debt, plus the possibility that he will appoint a more dovish Fed chair to succeed Powell (whose terms ends in 2026.)
The productivity hit will come from the effect of tariffs on forcing American companies to produce locally, at higher expense. American goods will become less competitive globally. Arguably that Tudor court approach mentioned above could also slow productivity as firms focus on lobbying the government instead of improving efficiency.
The hit to productivity is perhaps the least certain of my three arguments here. A case could be made that companies will indeed bring manufacturing plants back to the US but make them fully automated. That could encourage the rapid adoption of AI and robotics, technologies which seem increasingly ready for the big time.
What about a DIP in the economy in the form of a recession? Tariffs are a big tax rise and Trump may choose to go ahead with them early next year. Even if he planned to offset it with a cut in income taxes the latter would take time to come through. In any case much of the talk about tax cuts is really simply extending the existing tax arrangements which are due to expire at the end of next year. Negotiations on exactly where taxes are going will take up a big part of 2025. So a big rise in tariffs early in the year combined with dramatic moves to start deportations could sharply slow the economy.
The Fed would probably look through the rise in inflation, arguing that the economic slowdown would help bring inflation down later. If the slowdown looked like being a recession they would likely cut interest rates. Otherwise, they would probably just go slowly on interest rate cuts.
Not everything in Trump’s programme is bad for the economy. Far from it. The attempt to trim government spending (led by Elon Musk) could be helpful, though it depends what they cut. Also, the emphasis on corporate tax cuts, potentially taking the rate down to 15%, should help both business and stocks. Further, deregulation will be very welcome to many businesses. In his first term Trump required each new regulation to be accompanied by getting rid of two regulations. He has said in future each new regulation will need 10 regulations removed.
But the risk of an economic slowdown accompanied by disruption, inflation and a slowdown in long-term productivity growth is significant. Beware the DIP!
Comentários