From a financial historian's perspective, 2020 will go down as one of the most active years in the modern era. A number of events sent the capital markets into a state of flux, namely the coronavirus (COVID-19) pandemic. Amid the presence of COVID-19 and subsequent economic shutdown, the world's currency, commodity, debt and equity markets experienced unprecedented volatility. Governments and central banking authorities took dramatic steps to stem the tides of the swiftest downturn since the Global Financial Crisis of 2008.
In addition to the COVID-19 contagion, 2020 brought one of the most hotly contested presidential elections in U.S. history. The election frequently took on a confrontational tone, featuring a voracious standoff between pro-business Republican incumbent Donald Trump and change-oriented Democratic nominee Joe Biden. Among the key political issues were management of COVID-19, social unification and economic recovery. Each candidate brought a vastly different view of how to address these subjects, with many of the largest differences being rooted in finance.
Given the wide gap between economic ideologies, traders and investors are well-advised to prepare for a multitude of post-election scenarios. So, how would the markets react if the sitting President of the United States (POTUS) Donald Trump is elected to a second-term? The answer to that question is rooted in two primary issues: deregulation and tax cuts.
On the campaign trail of 2016, Republican candidate Trump made the case that excessive government regulation was costing taxpayers and the U.S. economy billions of dollars per year. Accordingly, he promised to "cut the red tape" facing numerous industrial sectors. In a statement from 17 December 2017, Trump summed up the new approach to deregulation:
"One of the very first actions of my administration was to impose a two-for-one rule on new federal regulations. We ordered that for every one new regulation, two old regulations must be eliminated. As a result, the never-ending growth of red tape in America has come to a sudden screeching and beautiful halt."
On 21 October 2019, the Budget and Spending department of the White House followed up on the issue of deregulation. The administration highlighted their accomplishments in an official statement:
- The Administration cut eight and half regulations for every new rule
- Deregulation efforts cut administrative costs by an estimated US$50 billion
- Sixteen pieces of deregulation legislation signed by Trump were expected to increase annual real incomes by more than US$40 billion
Generally speaking, sweeping deregulation of industry is viewed as being positive for small business, corporate and economic growth. The Trump administration lauded these efforts, stating that cutting existing regulations was to create six million new jobs, rising wages and low unemployment.
The results of Trump's first-term reform movements were palpable. Growth in the U.S. energy and auto industries paced economic development, contributing to a meteoric rise of U.S. equities. In the first 19 months after Trump took office, U.S. gross domestic product (GDP) grew at more than 3%, American unemployment fell to 50-year lows and the U.S. stock market spiked by 27% reflecting a significant jump in corporate profits.
The gains for U.S. stocks extended into February 2020, with the Dow Jones Industrial Average (DJIA), S&P 500 and NASDAQ Composite trading at all-time highs. Values of the U.S. dollar (USD) remained relatively firm versus global majors as the United States Federal Reserve (Fed) maintained a prime interest rate of 1.50%. In addition, American Unemployment measured 3.5%, the lowest such rate since the late-1960s. Upon the March 2020 onset of COVID-19, however, all conventional economic metrics fell by historic margins.
A second-term for the Trump Administration is likely to bring more widespread deregulation. Rules facing industries such as energy extraction, business/mortgage financing and emission standards top the list for revision. In the event that these objectives are achieved, broad economic growth and sectoral equities appreciation are probable.
Similar to deregulation, tax cuts were an integral theme in Trump's 2016 bid for the White House. And, on 20 December 2017, the Tax Cuts and Jobs Act (TCJA) was signed into law. Lauded by the Trump Administration as being the largest tax cut in U.S. history, the TCJA brought several big shifts to the American tax code. Below are a few of the highlights:
- Enhanced standard deductions of US$24,000 for married couples and US$12,000 for individuals
- Raised personal exemption amounts for the individual Alternative Minimum Tax (AMT)
- Reduced the U.S. corporate tax rate from 35% to 21%
- U.S. corporate tax rates move from a worldwide taxation system to a regional taxation framework
The TCJA was designed to provide a financial benefit to middle-class American workers and promote the return of corporations to the U.S. According to a White House press release from 15 April 2019, the TCJA accomplished both of these objectives:
- The TCJA created US$5.5 trillion in gross tax cuts, 60% of which goes to families
- More than 6 million workers received pay raises or bonuses in response to the tax cuts
- Year-over-year nominal wage growth grew at or above 3% for eight straight months (August 2018-April 2019)
- Real GDP grew by 3% from Q4 2017 to Q4 2018, the fastest rate since 2005
- Businesses poured investment back into the U.S., repatriating more than US$500 billion in 2018
Although the long-term impacts of the Trump tax cuts are debatable, the intermediate-term influence was viewed as positive by the markets. After a tumultuous 2018, the DJIA (+22.3%), S&P 500 (+28.9%) and NASDAQ (+35.2%) each put in extremely positive years. In addition, the U.S. experienced falling unemployment, steady GDP growth and a firm USD. Due to these metrics, the Trump Administration wasted no time praising the TCJA's effectiveness.
Going into the 2020 election, Trump gave unfettered support to further tax cuts. If re-elected, Trump promised a series of reforms over and above the TCJA, specifically pertaining to capital gains and payroll taxes:
Capital Gains Tax
"I'm going to do a capital gains tax cut to 15% in the second term. We're going to get it down to 15%. It's at 21%. We'll get that down to 15%. I'll get that done easily."
"I will sign a directive instructing the Treasury Department to allow employers to defer payment of the employee portion of certain payroll taxes from September 1st (2020) through the end of 2020."
In a later quote, Trump alluded to these cuts becoming permanent: "If I'm victorious on November 3rd, I plan to forgive these taxes and make permanent cuts to the payroll tax."
Should they come to pass, reductions in the capital gains and payroll taxes are likely to be viewed as favourable by the markets. Increased consumption, investiture and positive sentiment are probable results. While far from guaranteed, more Trump tax reforms could act as a catalyst for an extended period of U.S. economic and financial market growth.
In addition to deregulation and tax cuts, another four years of Trump as POTUS will bring numerous other issues to the financial markets. As of this writing (September 2020), the U.S./China trade war has yet to be resolved and the long-term impacts of COVID-19 are still in question. These two issues consist of countless moving parts and feature unpredictable final results.
Historically, it is unclear what a Trump second-term will mean to the markets. According to Jeremy Siegel, professor of finance at the Wharton School of the University of Pennsylvania, uncertainty dominates the landscape:
"Stock markets do perform better under Democrats than under Republicans. That's a well-known fact, but it does not imply cause and effect. Bull markets and bear markets come and go, and it's more to do with business cycles than presidents."
Despite the uncertainty, one can make a case that Trump's re-election bodes well for the financial markets. Sweeping industrial deregulation and tax cuts will set the stage for investiture and economic growth; strong equities market performance is likely to reflect these elements.
Additionally, an eventual exit from the Fed's 2020 policy of "unlimited quantitative easing (QE)" will lead to a strengthening of the USD. Although the timelines for these events are largely unknown due to COVID-19, both are potential market reactions following a Donald Trump victory in the 2020 U.S. Presidential Election.