Overview
It is rare to have a complete change in the operational environment, but in our opinion, we are in the midst of one with deep and broad implications for institutional investors and risk managers.
A Change in the Status Quo
Rarely have the political parties been as divided as they were in this past election, with the massive exchange of insults and worse. Our view is that with Mr. Trump’s win and likely control of both houses, the agenda and speed of changes will surprise many. Below is a quick summary:
- Government Employment – Mr. Musk has been a central figure in the Trump campaign, and his influence is likely to continue, at least in the initial phase of the new administration. Above is an illustration of the growth of federal workers over the past several years (excluding federal contractors and recipients of federal subsidies). Mr. Musk reportedly cut the workforce of X (Twitter) by 80% and seemingly hopes to do the same with the Federal government as indicated by his recent posts on X and his public statements.
Impact: The new administration expects to reduce costs and alleviate burdens on businesses. Note that workforce costs account for approximately 8% of the federal budget (Source: Google AI Overview).
Risk: The risk, of course, is abuses by business as regulations are lifted. - Taxes – Typical of many Republican platforms, Mr. Trump plans to continue and expand Federal tax cuts. Given the likely Republican control of both houses of Congress, the probability of such cuts being enacted is high.
Impact: The notion is not new, but the concept is that the tax cuts will be more than made up by an acceleration of the economy.
Risk: Given the Federal budget deficit of 7%, many observers are concerned that tax cuts will exacerbate deficit problems. The recent rise in Treasuries probably reflects that concern. - Energy – Mr. Trump and many others in Republican circles maintain that allowing more drilling will reduce energy prices and, in turn, reduce inflation. An added benefit is increased government receipts.
Impact: There is little doubt that energy production can increase, particularly via enhanced fracking techniques. Subsidies and tax benefits for renewable energy sources will likely decrease.
Risks: There have long been concerns about the continued use of fossil fuels; many argue that solar remains one of the easiest avenues for meeting increased energy demands. - Tariffs – Mr. Trump has long proposed using tariffs to return manufacturing to America and coax other nations into a more amenable position.
Impact: It is probably useful to separate the rhetoric from the reality. We expect that the threat will be a means for adjusting others’ expectations and coming closer to accepting proposed terms.
Risks: America is not the sole superpower it was over the past couple of decades and some adversaries now appear to be more united. Further, given the broader use of automation (see prior risk commentary), if American manufacturing is to return, labor may be a less valuable component to production than it was in prior generations. - Foreign Policy – Mr. Trump has claimed that he could end the war in Ukraine within 24 hours. Perhaps that is true, but at what cost? In 2016, Mr. Trump campaigned on a withdrawal from Afghanistan, which did not manifest in his first term. Instead, the conflict was de-escalated, but American involvement continued. Unfortunately, war is messy, and the slogan “America First” is probably not the best calling card for gaining the support of allies.
Regarding Israel, our expectation is that Mr. Trump will repeat the path he used in his first administration (see the Abraham Accords), although Iran is probably a bigger threat with its nuclear capability.
Impact: Watch for Mr. Trump to insist that Europe, Taiwan, and Japan bear a greater portion of the defense costs.
Risks: Mr. Trump’s hard-nosed negotiating style runs the risk of alienating partners such as France and Germany.
Summary
Above are the major areas which need attention but watch for us to add to the list if we provide an update.
Nota Bene: While many political observers follow polls, and spend considerable sums for such polls, it appears the wisdom of the markets is a better indicator of likely results. Below is an excerpt from today’s NY Times DealBook¹:
“Proponents of prediction markets such as Polymarket, Kalshi and PredictIt, where bettors could wager on the outcome of the election, said they reflected reality faster and better than opinion polls. With Donald Trump’s resounding win, those claims seem to have been borne out.
“History was made today,” Shayne Coplan, the C.E.O. of Polymarket, wrote on X, claiming that “the Trump campaign HQ literally found out they were winning from Polymarket.”
The average odds from five political betting markets — Betfair, Kalshi, Polymarket, PredictIt and Smarkets — showed Trump with better-than-a-coin-flip odds heading into Election Day, according to the aggregator site Election Betting Odds. By the time polls closed, the chances of a Trump victory shot up. (Worth noting: Polls measure how voters plan to vote, while prediction markets track the odds that a candidate will win implied by bets on the platform.)”
Sources
[1] https://www.nytimes.com/2024/11/06/business/dealbook/prediction-markets-trump-win.html