What is the market expecting if Trump gets a second term
Although former President Trump has yet to fully outline his formal economic plan, his priorities remain clear: deregulation, lower taxes, and opposition to green initiatives. In his first term we saw this unfold, Trump slashed the corporate tax rate from 35 to 21% and lowered individual taxes across the board. He’s now signaling at a potential further cut in corporate taxes to 15%.
The impact of tax rate cuts is relatively straightforward: lower taxes tend to boost real output growth and corporate profits, so they’re considered bullish for equities. We witnessed this during his first term through the so-called “Trump Trade,” when the S&P 500 surged by 67% and the Nasdaq by 135%. By and large, the corporate sector is supportive of lower corporate tax rates and deregulation. Eliminating taxes on tips also has bipartisan support. On the other hand (in 2018), he launched a tariff war against China, lifting the tariff rate from 4 to more than 25% and he’s recently hinted at increasing this up to 60%. The business sector is leery about rising tariffs and strict trade restrictions, as these will have negative implications for business and profits. The sharp selloff in semis stocks last week on Trump’s comment that Taiwan should pay for its defence is an acute reminder of the possible arrival of turbulent times with respect to trade, capital flows, technology, and tariffs.
The net result will largely depend on whether his radical proposals are just political noise or something that will be followed through and become actual policy. Regardless, it will impact all sectors of the broader economy.
For equity performance, we believe that the following sectors will be winners under a Trump second term:
- Defense and Aerospace: benefiting from an increasing defense budget; significant changes from Trump’s first term included the rebuild of the United States military with over $2.2 trillion in defense spending, including $738 billion for 2020 after 8 years of decline under the previous administration. The establishment of the Space Force, upgrades to cyber defenses and the modernisation of the missile defences and nuclear forces.
- Industrials: “bring manufacturing home”; Tariffs are a hallmark of Trump’s economic agenda. An increase in tariffs on all foreign goods should, in theory, increase domestic production and manufacturing.
- Financials: deregulation; According to those close to Trump, if elected for a second term, would seek to sharply reduce the power of U.S. financial regulators. This would allow companies to operate more freely and potentially stimulate the economy.
- Auto: protect the U.S. auto industry. In his speech at the Republican National Convention, Trump outlined his plan to revive the U.S. automotive industry. Trump said he would end the Biden administration’s electric vehicle mandate and increase car manufacturing in the U.S
Losers include:
- Clean energy: disbelief in climate change; During his term as US president from 2017 to 2021, Trump withdrew the United States from the Paris Agreement on climate change and has vowed to again pull out of the accord that the US has since rejoined under the Biden administration. Trump once called climate change a hoax and his campaign rallies often include chants of “drill, baby, drill”. He believes increasing oil and gas production will make the US the worlds top energy producer.
- Chip makers: tighter restrictions on China trade; Taiwan produces more than 90% of the world’s most advanced chips, but earlier this year, Trump questioned why the US was acting as Taiwan’s “insurance” when, he claimed, it had taken away America’s chip business.
- Lower material prices: relaxing environmental restrictions and regulations;
Reasons for a rotation from Tech to other industries/sectors (S&P493)
Over the past couple of years, a substantial portion of S&P500 returns have come from the Magnificent Seven tech stocks, making up around 33% of the S&P500 index. It has accounted for over 60% of the returns thus far year to date.
The most notable feature of the S&P 500 is that it is market cap-weighted. This means each company is ranked 1-500 based on the total size of their market capitalization (essentially how much the company is worth or valued at) and given a weighting to index that is representative of their size versus the size of all 500 companies. Currently, Apple is the biggest company in the US and has a weighting of around 7% in the S&P 500. Paramount Global is the smallest company in the index and has a weighting of 0.01%. So, for every $100 you invest in the S&P, $7 is invested in Apple, and $0.01 is invested in Paramount Global.
Recent shifts in favourable economic data pointing to lower inflation with future interest rate cuts combined with recent quarterly earnings indicate that perhaps AI spending may take longer to pay off than originally expected – And investors have started rotating their positions from The Magnificent Seven into the other 493 stocks making up the S&P500.
S&P 500 YTD Return 13.39% (USD), S&P 500 Equal weight ETF 8.89% (USD). 3-month return – S&P 500 1.04% (USD) and the S&P 500 Equal weight ETF 4.34% (USD). We believe that three key factors indicate the potential for the S&P 493 to outperform the Mag Seven in the near future:
Firstly, is the valuation Gap. As of early September, the average P/E ratio of the Mag Seven stood at around 40 TIMES, in contrast, the average P/E ratio of the remaining 493 companies at 16. Sixteen is much closer to historical norms offering a more attractive entry point. This stark difference in valuations suggests that much of the future growth potential of the tech giants is already priced in, leaving the S&P 493 with more potential upside.
The influx of money into the Magnificent 7 has no doubt been amplified by the growth in popularity of Exchange-Traded Funds (ETFs) which track stock market indices such as the S&P 500 and the technology-heavy Nasdaq 100. Consequently, 4 US-listed ETFs based on the S&P 500 or Nasdaq 100 indices gathered a massive $100 billion in new fund inflows over the first 6 months of this year.
Secondly, the Potential Impact of a Lower Interest Rate Environment whereby participants believe that lower interest rates could significantly benefit the broader market – Particularly sectors that rely heavily on debt financing, such as industrials, real estate, and consumer discretionary.
Lastly, potential shift in Growth and Value Strategies – Historically, markets have gone through cycles where growth stocks lead for a time, followed by periods where value stocks take the lead. After years of dominance by the tech-heavy growth stocks, some analysts expect a market rotation towards value.
General Outlook going forward:
Lower rates would likely reinvigorate consumer demand and corporate investments, driving growth in sectors like retail, construction, and manufacturing—areas where the S&P 493 has more exposure than the tech-heavy Mag Seven.
An important to note, in times of market volatility, like we are observing now leading up to elections and changes in monetary policy – Defensive stocks tend to outperform due to their stable earnings and lower sensitivity to downturns. Defensive sectors such as healthcare, consumer staples, and utilities make up a substantial portion of the S&P 493 and have plenty of catching up to do.
Summary
While former President Trump’s economic plan remains partially undefined, his focus on deregulation, lower taxes, and skepticism towards green initiatives is clear. His previous term saw significant tax cuts and deregulation, which were bullish for equities, leading to a notable surge in stock indices.
However, Trump’s stance on trade, including his recent comments and the prospect of increased tariffs, introduces uncertainties. The business sector is wary of such measures, which could negatively impact profits and create volatility in markets related to trade and technology.
Regarding the broader market, a notable rotation from tech stocks to other sectors is underway. While the Magnificent Seven tech stocks have driven substantial S&P 500 returns, recent economic data and shifting investor sentiment suggest potential opportunities in the remaining 493 S&P 500 stocks. Factors such as valuation disparities, the impact of lower interest rates, and a possible shift from growth to value stocks support this trend. Lower rates could rejuvenate consumer and corporate spending in sectors with significant exposure beyond tech.
Overall, while Trump’s policies will likely influence various sectors, market dynamics, and economic conditions will shape sector performance. In times of volatility, defensive stocks may offer stability, presenting opportunities for investors to consider a broader allocation across the S&P 493.
