How much of Trump’s policy agenda should be priced in?

Words by David Rogers, Markets editor at The Australian

Donald Trump’s historic return has sparked big moves in global financial markets.

Stocks have experienced a sustained rise but much of the initial reaction in currencies, commodities and bonds was soon unwound in volatile trading after Trump’s victory became clear this week.

In reality, nothing much will happen before Trump’s inauguration on January 20 and the amount of policy change that markets should build in at this stage is unclear.

Even with Republican control of the Senate, and what looks to be a majority in the House of Representatives, it’s not clear how much of Trump’s policy agenda will be implemented.

For the US stockmarket, the next couple of months should be a period of exuberance amid speculation of stronger economic growth under Trump’s pro-America and pro-business stance.

Owning shares in US-exposed companies at this point should also align with year-end tailwinds.

Hedges against election risks have been unwound, with gold coming off and stock volatility cooling. Money flowing out of money market funds and gold could still find its way into stocks.

Falling volatility should lead volatility-targeting funds to buy more stocks. Underperforming US fund managers tend to invest more into year end as US corporate buybacks of stocks resume.

US earnings estimates are being revised up and most central banks are cutting rates.

Both the Federal Reserve and the Bank of England cut rates as expected on Thursday.

US ETF inflows of $US18bn ($27bn) on Thursday were 16 times the daily average inflow this year.

The Australian sharemarket is following the US market, albeit at a slower pace, as it has both “winners and losers” from Trump 2.0, mainly in terms of the amount of US versus China exposure.

China’s policy announcements after its National People’s Congress this week will be key.

But despite uncertainty about the full extent of US policy change under Trump, some economists have revised their forecasts.

“Given the US election results, we embed increases in import tariffs and tighter restrictions on immigration into our baseline outlook,” Barclays chief US economist Marco Giannoni said.

“We raise our inflation projections and lower GDP growth in 2025-26 due to the likely implementation of import tariffs and tighter immigration restrictions.”

Accordingly, he has revised up his projected path for US interest rates.

“We now think the FOMC will cut rates only twice next year, by 25 basis points in March and June, and twice again in 2026,” Giannoni said.

He still thinks the FOMC will cut another 25 basis points in December but now sees this as “a close call with rising risks of a pause”.

Barclays’ core US PCE inflation forecast for the end of 2025 has been revised up from 2.3 per cent to 2.7 per cent. Its US economic growth forecast has been revised down from 2 per cent to 1.8 per cent.

Despite the slower pace of activity and employment, Giannoni sees the unemployment rate falling to 3.9 per cent by the end of 2025, reflecting a tighter labour market due to reduced immigration.

Goldman Sachs is taking more of a wait-and-see approach to Trump’s policy agenda. The US investment bank hasn’t changed its US economic forecasts as yet.

Chief US economist David Mericle still expects back-to-back rate cuts of 25 basis points by the Federal Reserve at its meetings in December, January and March.

But he now expects the final cuts in June and September, versus May and June previously, after Fed chair Jerome Powell indicated that the Fed may slow the pace of cuts near the end of the cycle.

For the stockmarket, Goldman Sachs says investors should consider the usual post-election path of the S&P 500 index; equity investor positioning; potential rotations within the market including those relating to trade and tax policy; and the outlook for corporate M&A and IPO activity.

Chief US equity strategist David Kostin sees the S&P 500 hitting 6300 points next year on the back of strong earnings growth. He sees earnings per share growth of 11 per cent in 2025 and 7 per cent in 2026, subject to change as the new administration’s policy agenda becomes clearer.

“The prospect of trade conflict poses downside risk to these estimates, while the potential for changing regulatory and corporate tax policy pose upside risks,” he said.

But a key driver for stocks in the near term will be the reduction in political uncertainty. The S&P 500 index has historically risen 4 per cent between election day in November and year-end.

Along with the resolution of election uncertainty, resilient recent economic growth data and continued rate cuts support the near-term outlook for US stocks.

A further sharp increase in 10- year Treasury yields could limit the magnitude of any potential rally in stock prices. Kostin says equities have absorbed an 80 basis point rise in the 10-year yield in the past seven weeks because it was mainly driven by better economic data.

Encouragingly, investors reduced equity market exposure before the election.

Goldman’s Equity Sentiment Indicator, gauging stock positioning across retail, institutional and foreign investors, suggests that collectively they are only modestly above their 12-month trend.

“While investor equity positions are not low, Goldman Sachs Prime Services data indicate that hedge funds have reduced both net and gross leverage in recent weeks ahead of the election,” Kostin said.

“Similarly, the increase in implied volatility in recent weeks has matched the historical pattern ahead of elections, likely reflecting hedging activity.

“As political uncertainty declines and investor positioning normalises, an increase in length should support the typical pattern of S&P 500 appreciation following presidential elections.”

Kostin also notes that various US stocks and industries have tracked election betting markets, reflecting investor perception of how postelection policy outcomes could affect fundamental outlooks.

“While Inauguration Day and any subsequent policy changes are still months away, these recent relationships suggest themes including small-caps and financials will outperform and renewable energy stocks will lag as the market moves from pricing roughly 55 per cent odds of a Trump victory to fully pricing that outcome,” he said.

Kostin notes the recent performance of stocks with domestic US revenues and supply chains relative to international-facing firms correlated with prediction market odds of a Trump victory.

GS economists expect Trump will impose tariffs on China averaging an additional 20 percentage points. That is much less than the 50-60 per cent that Trump has called for.

On fiscal policy, if Trump’s proposal to cut the corporate tax rate from 21 per cent to 15 per cent is enacted, it would boost Goldman’s earnings per share estimate for the US sharemarket by about 4 per cent.

Kostin also says the regulatory posture of the Federal Trade Commission and Department of Justice Antitrust Division, which challenged many proposed business combinations in the past four years, will likely be more
relaxed under the incoming administration.

Continued economic expansion coupled with an improvement in CEO confidence suggests M&A activity will increase next year.

Kostin expects $US4 trillion of corporate spending in 2025 will be roughly evenly split between returning cash to shareholders via buybacks and dividends, and investing for growth via capex, R&D and M&A.

This article first appeared in The Australian