The election of Donald Trump marked an important turning point in financial markets. It also resulted in a new phrase, “Trump Trade.” It is a set of asset classes, sectors, and market drivers that will do well with the new President’s policies. The policies generally center around three items: tax reform, deregulation, and infrastructure spending. Let’s examine each of these, describe the specific market movements, where we are currently economically, and the risks, writes Ketu Desai. – @Siliconeer #Siliconeer #Business #Finance #Investments #Investing #MarketTrends @KetuDesai #TrumpTrade

President Trump and Congressional Republicans agree that there should be lower rates and a broader taxable income base. Trump wants to reduce the number of tax brackets to about three from seven, and reduce the highest rate from 39.6% to 33%.  They would also look to simplify the process and deductions. For corporate taxes, he wants to reduce the rate from 35% to 15%, and also simplify the process. Trump has said that we should get more specifics over the coming weeks. The question many will ask is how do we make up the revenue difference?

Deregulation and infrastructure will be ongoing. President Trump has said he wants to cut regulations by 75%.  Further, he has said that for every new regulation, two must be eliminated.  He has already started with certain financial deregulation and will likely focus on some deregulation related to the EPA.  Over time, President Trump wants $1 trillion of investment in infrastructure.  He wants to improve our roads, hospitals, bridges, tunnels, airports, etc.

The objective of these policies is to stimulate economic growth. If taxes are lower, consumers and businesses have more capital to spend and invest. If there is less regulation, it is easier to conduct business, get new projects approved, and most likely cheaper to do business. Infrastructure projects are job creators. All of these items are positive for economic growth, and that is what the market has been reacting to.

The “Trump Trade” for the economy means higher economic growth, higher inflation, higher interest rates, and stronger U.S. Dollar. The policies above are aimed at higher economic growth, however, with higher economic growth comes higher inflation due to higher demand for goods, services, and labor. As inflation increases or is expected to increase, the Federal Reserve increases interest rates to prevent overheating of the economy.  Further, investors sell bonds, which has the impact of increasing interest rates.  Lastly, the U.S. dollar appreciates because global investors invest in the U.S. because of its higher growth rates and interest rates, relative to other developed markets.

What does the “Trump Trade” mean in terms of markets? The “Trump Trade” has meant investors favoring assets that perform well with these policies. More specifically, it has meant equities over fixed income; investors favoring domestic over foreign; investors favoring growth over yield; investors favoring cyclical over defensive. It has created a market environment where there are certain asset classes, sectors, and companies that are winners and others that are losers, many of which in a bifurcated way.

One of the clear risks to these pro-growth policies at this point in the economic cycle is that the economy over-heats causing rapid inflation. This could potentially cause a decrease in purchasing power for Americans, if wages do not keep up with inflation. Further, the Federal Reserve would have to act more aggressively in increasing interest rates. Ultimately, it could lead to a crash in the market. There is also much risk in how the policies are implemented and often with such policies the devil is in the details. There are other risks such as having too strong of a U.S. Dollar that hurts in trade. Unforeseen risks are also worth being cognizant of with such drastic changes in the outlook.

There is a lot going on in financial markets with much to be gained and lost, stay tuned!

Interested readers can reach Ketu Desai by email ketu@isquaredwealth.com.