Had I found any takers, I would have bet that I would wake up the day after the November 6 presidential election without knowing for sure who the next U.S. president would be. But I was wrong. Others were also caught off guard; 43 percent of people expected a one-week delay in declaring who won the election, according to Fundstrat.
Instead, investors knew President-elect Trump won by the time the stock market opened the next day. The S&P 500 popped 2.5 percent, its best one-day return the day after a presidential election ever. You have to imagine that some of that gain was due to the unexpected clarity of knowing who will be shaping fiscal policy for the next four years. And if that is true, then there should be a component of that gain tied to the expected fiscal policy.
The 2024 campaign was unusual in many ways. The one that made me facepalm the most is that both President Trump and Vice President Harris would tell America what they would do if elected—Trump with new tariffs and massive deportations and Harris with new taxes on unrealized gains and giant increases on capital gains—then their surrogates would come out and soften the rhetoric by saying something like, “Well, that’s not exactly what they meant… don’t worry about it.”
Whether it was Trump or Harris, clarity was never going to be on the menu. So, what can we expect in a Trump economy, and what aren’t we sure about? I am not sure about tariffs or immigration.
The textbook will tell you that tariffs are bad for the economy because they are inflationary. During Trump’s first term, he placed new tariffs on something like $430 billion of goods. However, the average growth rate of U.S. GDP for each of the four years he was in office was 2.75 percent. That is excellent (also, inflation was not a concern then).
But then President Biden came to office. Not only did he keep all those tariffs, but he added an additional $18 billion. The average U.S. GDP growth rate for each of Biden’s four years in office will be about 3.5 percent when we get the final numbers. That is amazing (and of all the potential reasons discussed for inflation under Biden, tariffs carried virtually no weight).
I cannot prove the counterfactual—perhaps growth would have been higher without tariffs. Still, it shows that tariffs will not ruin the economy if other good things happen. More broadly, regarding GDP growth, we do not need to worry about fiscal policy if the right things are happening elsewhere.
The textbook also says a declining population harms local and national economies. I am not ready to throw that textbook out because you can see it happening not just in the textbook but in practice around the globe.
If Trump were to deport the estimated 11 million unauthorized immigrants in the U.S., the question would not be, “Is that bad for the economy,” it would be, “How bad will it be for the economy?”
Many industries rely on immigrant labor. Overall, unauthorized immigrants make up nearly five percent of all U.S. workers. Close to one-third of workers in the construction trade are immigrants, for example. If those workers were forced to leave, it would significantly impact housing and other construction since those sectors already face a shortage of employees. Other affected industries include agriculture, manufacturing, transportation, retail, hospitality, and childcare.
GDP is roughly equal to the productivity growth rate plus the growth rate of prime-age workers. Losing workers would be harmful to the economy.
Logistically, deporting 11 million people in four years would be challenging.
At its peak, during the Obama administration, the U.S. Immigration and Customs Enforcement (ICE) agency deported 400,000 immigrants per year. Obama deported a total of 5.3 million unauthorized immigrants during his eight years, including removals and returns. That was such a large number that President Obama was dubbed the “Deporter-in-Chief.”
The average GDP growth rate for the Obama years was 1.9 percent, roughly the long-term trend. The average unemployment rate was 6.4 percent, well above the Trump and Biden years (other than the spike during the pandemic). That mix of trend-like GDP growth (in contrast to “excellent” or “amazing” growth) and lower demand for labor is different from today’s situation; labor supply is currently needed.
President-elect Trump announced Thomas Homan, the former acting director of ICE, as his administration’s “border czar.” Homan served as the executive associate director of ICE under Obama; Obama presented Homan with a Presidential Rank Award as a Distinguished Executive. In 2017, Trump promoted Homan to acting director of ICE. While serving under Obama, a Washington Post article stated, “Thomas Homan deports people. And he’s really good at it.”
Assuming current laws are not changed, as of 2023, it took an average of four years to resolve a deportation case. However, let’s assume the legal process is relaxed and the Obama-era number of deportations doubles to about 800,000 people annually; about 3 million immigrants would be removed over Trump’s four years. An estimated 2 million unauthorized immigrants may decide not to enter the U.S. due to heightened security and decreased immigrant benefits. That is a net 5 million fewer unauthorized immigrants. The direct output losses, cascading effects on consumption, and declining productivity in affected industries would reduce U.S. GDP by one-half to one percent annually.
The president can issue executive orders to facilitate tariffs and immigration. However, changing taxes is not that easy.
Lower corporate tax rates should be helpful to stock prices as they increase companies’ post-tax profits and make them more attractive to investors. Trump will not raise corporate rates, as Harris pledged to do, which should support stock prices. Trump even talked about cutting corporate tax rates from 21 percent to 15 percent for companies that manufacture in the U.S. For tax cuts, the president needs Congress to pass legislation. Republicans have a slim majority, but he may have to negotiate with Democrats and raise the cap on the state and local tax deductions or increase the child tax credit to get what he wants. Trump may even receive resistance from Republicans who are concerned about the deficit.
The degree to which the economy is positively or negatively impacted will depend on the timing and magnitude of policy changes. But as I said earlier and have been saying for some time, while the president’s actions are critical to the economy, corporate innovation and the animal spirits of consumers and investors are more important. Fiscal policy is part of the equation, but it is not the answer.
A recent trade
While part of my job is to consider what will happen, eventually, I have to decide—either trade or don’t trade. Last week, I made a minor allocation shift for my investment that leans anywhere from “moderate” to “aggressive.” I sold my foreign positions (about a three percent allocation) and placed the proceeds in small-capitalization U.S. stocks using the iShares Russell 2000 exchange-traded fund (symbol: IWM)
The Federal Reserve lowered interest rates by one-quarter of one percentage point last week to a range of 4.5 to 4.75 percent. It has been 16 months since the Fed last raised rates during its campaign to fight inflation. I have taken a measured approach to investing in small caps out of concern that higher capital costs would impact the margins of smaller companies. The Fed’s trend of higher-for-longer interest rates is changing, catalyzing improved margins for these companies and making them more attractive investments.
Also, it is likely that Lina Kahn, the commissioner of the Federal Trade Commission, will be replaced with someone more business friendly. That would create a path for mergers and acquisitions, allowing for more economies of scale and better profits for acquired companies. Also, the Trump administration is expected to loosen business regulations. Small companies often feel a heavier burden than larger companies because they don’t have the same access to resources; deregulation should reduce costs for smaller firms, potentially boosting their profitability and investment appeal.
Trump 2.0?
Will the stock market’s performance under Trump’s second term be similar to his first? If so, that small-cap trade might be short lived. But remember, valuations, trends, interest rates, etc. are different now than during his first term. Nonetheless, if stock market performance were repeated, small caps would outperform the broader market for the remainder of the year, and then technology stocks would play catch-up.
According to the DataTrek chart above, U.S. small-cap stocks (Russell 2000) outperformed large caps (S&P 500) by 8.9 percentage points from Election Day 2016 through year end. Non-U.S. stocks (ACWX) struggled through that period. Sometimes, history repeats. But often, historical returns are not an indication of the future. Either way, it is almost always interesting to look at.
Allen Harris is an owner of Berkshire Money Management in Great Barrington and Dalton, managing more than $700 million of investments. Unless specifically identified as original research or data gathering, some or all of the data cited is attributable to third-party sources. Unless stated otherwise, any mention of specific securities or investments is for illustrative purposes only. Advisor’s clients may or may not hold the securities discussed in their portfolios. Advisor makes no representations that any of the securities discussed have been or will be profitable. Full disclosures here. Direct inquiries to Allen at AHarris@BerkshireMM.com.