After Trump's win, the stock market has been on a tear. But unlike last time, when the pro-business president drove stocks to record highs, another bullish term is far from certain.
Trump's campaign secured the presidency by promising deregulation, sweeping tax cuts, and trade policies designed to make American industries more competitive.
Trump vowed to make Americans more prosperous through stronger economic growth, more plentiful jobs, and bigger 401(k) balances.
However, investors relying on Trump's campaign promises to make big bets on particular industries or stocks should think twice.
"There's so much uncertainty right now," Jeremy Goldberg, a certified financial planner, said of Trump's second term. "I wouldn't be making large bets one way or another."
For starters, Trump is inheriting an economy that's weaker and far more indebted than it was in 2017. The ballooning deficits could make it harder for Trump to pursue his vision.
If it falls short, the "Trump trade" might resemble more of a roller coaster than a bull market.
Funding shortfalls make tax cuts difficult to swallow
During Trump's first term, the U.S. federal deficit ballooned, driven by a combination of tax cuts, increased spending, and the economic consequences of Covid.
In Trump's first year as president, the deficit reached $584 billion, or 3.1% of GDP. Fast forward to 2024, the federal deficit is projected to hit a whopping $1.9 trillion, or 7% of GDP.
Meanwhile, the total national debt now stands at an eye-watering $36.1 trillion.
The Treasury Department has issued $28 trillion worth of bonds to fund the government's spending spree. But as Washington's fiscal position continues to deteriorate, bond investors aren't lining up to buy Treasurys like they used to.
They're beginning to worry about the sustainability of U.S. fiscal policy and Uncle Sam's ability to manage his fiscal obligations. Even members of the GOP have acknowledged this reality.
"In a weird way, the bond market is now on the verge of running this country," said Republican Rep. David Schweiker, who sits on the House Ways and Means Committee.
While economists generally agree that tax cuts are good for citizens and businesses, they must be accompanied by an equal or greater reduction in government spending, or else the whole thing is unsustainable.
Unless things change, Trump's proposed tax cuts could increase the national debt by $7.75 trillion through 2035, according to the nonpartisan Committee for a Responsible Federal Budget (CRFB). But that's only the tip of the iceberg.
According to the CRFB, the deficit could grow by $15.5 trillion if Trump's other spending plans come to fruition.
It may be easy for the average American to shrug off the mounting deficit, but seasoned investors know better.
Research from the Congressional Budget Office (CBO) shows that every percentage point increase in the nation's debt-to-GDP ratio increases the inflation-adjusted 10-year interest rate by 2 to 3 basis points.
In other words, growing deficits lead to higher interest rates, which crowds out private investment. The same CBO study found that, for every $1 dollar increase in the federal deficit, private investment falls by 33 cents.
These figures suggest that cutting taxes isn't the silver bullet that the Trump team thinks it is.
"Cutting taxes is easy. We know from experience that substantive spending cuts are impossible," wrote economist Peter Schiff.
"Even Reagan couldn't do it, despite making greater promises to do so. Trump will make inflation great again," said Schiff.
Making "inflation great again" wasn't part of Trump's campaign promise, but it can still come true if policymakers don't put a cap on their borrowing and take decisive action to trim the deficit.
The inflation genie hasn't been put back in the bottle
While campaigning, Trump regularly criticized the Biden administration for causing "the worst inflation in American history, costing us and the typical family $28,000."
Trump was likely referring to the impact of cumulative inflation on the average American household. Although the Consumer Price Index (CPI) has cooled below 3%, consumer prices have been up more than 21% since early 2020.
Just because inflation spiked on President Biden's watch doesn't absolve Trump of any responsibility. Economists like Schiff say Trump was at least partly responsible for the post-Covid price surge and that his spending plans could lead to even more inflation down the road.
The 1960s and 1970s offer a historical case study of how government spending can go off the rails.
"The reason we had so much inflation during the 1970s was the deficit spending during the 1960s on the Great Society, the War on Poverty, the Vietnam War, and going to the moon," Schiff said. "Now, with the U.S. in worse financial shape, Trump has promised a Mars landing."
Inflation doesn't always show up immediately but takes years to trickle down through the economy—especially if it's being fueled by large government deficits.
Unfortunately for Trump, fiscal mismanagement isn't the only potential source of inflation. Economists warn that his proposed trade war could fuel price hikes for certain imported goods.
The impact of tariffs
If Trump's rhetoric is taken literally, the president is prepared to slap heavy tariffs on Chinese, Mexican, and Canadian goods shortly after inauguration.
According to the International Monetary Fund (IMF), Trump's proposed import duties would affect roughly $1.5 trillion worth of goods flowing through North America.
While Federal Reserve Chair Jerome Powell believes it's too early to determine whether these tariff threats would impact the U.S. economy, the bond market disagrees.
The threat of a tariff-induced inflation spike pushed bond yields higher leading up to the Nov. 4 election and in the weeks that followed. That means part of Wall Street is betting that inflation is here to stay, which could prevent the Fed from lowering borrowing costs next year.
Although Trump's cabinet says tariffs will protect domestic manufacturing jobs and boost federal revenues, economists and business groups generally agree that the duties will be passed onto the consumer in the form of higher prices.
According to the Consumer Technology Association (CTA), Americans' spending power on popular electronics like TVs, smartphones, video game consoles, and laptops could be reduced by $90 billion because of tariffs.
"The likelihood of retailers or any importer absorbing the tariff cost is very low, so the pass-through to consumers will be quick," said CTA vice president Ed Brzytwa. "On all the products we looked at, there are going to be price increases."
Sector performance not guaranteed
Anticipating the impact of a presidential administration on certain sectors of the stock market is easier said than done.
For example, financial, industrial, and energy stocks outperformed the S&P 500 in the first week after Trump was elected in 2016. Then, they significantly underperformed for the next four years.
"The market is known to have these knee-jerk reactions trying to anticipate where things go very quickly, but they don't necessarily last," said Larry Adam, chief investment officer at Raymond James.
Trump has vowed again to make America energy independent in his second term, but that doesn't necessarily mean oil and gas stocks will outperform. Despite massive deregulation and record oil production in Trump's first presidential term, the energy sector declined 8.4% under his watch.
Ironically, energy stocks have increased 22.9% during Biden's tenure, which was marked by promises to transition to renewable energy.
The best-performing sectors under Trump—information technology (30.8%) and consumer discretionary (21.1%)—weren't unique to his presidency. These sectors saw gains in the last three presidential administrations going back to Barack Obama.
While healthcare also performed well in Trump's first term, the sector is bracing for steep cuts to Medicaid and Obamacare under the Republican-led Congress. This could be a net negative for publicly traded health companies, according to David Weinstein, a portfolio manager at Dana Investment Advisors.
Other portfolio managers believe financial services are one area where the Trump administration can make a difference as the combination of banking deregulation and higher rates boost profitability.
But this could come at the expense of housing if interest rates don't decline fast enough to encourage more buyers back into the market.
Retail is another mixed bag. On the one hand, tax cuts may put more money in Americans' pockets, but on the other hand, their spending power could be diminished by tariffs.
Weinstein believes all physical retail goods, from footwear to appliances, are at risk from tariffs.
What it all means for investors
From a policy lens, Trump 2.0 is shaping up to be a roller coaster for investors.
The good news is that, on a long enough time scale, researchers have shown that presidential administrations and their party affiliations take a back seat to how the stock market actually performs.
As Larry Adam warned, there will be a lot of "knee-jerk reactions" to the incoming administration, but how its policies impact stocks is not as cut and dry.
What really matters is the economy, the performance of individual companies, and whether central bank money printers are humming. But one area where Trump can really shine for now is in public opinion.
Trump's election has already powered business sentiment to multi-year highs. More confident leaders are more willing to grow their companies if they believe they're in a pro-business environment.
As asset manager VanEck reported, Trump's election win "fostered a wave of market optimism," but it remains to be seen whether this will translate into a full-fledged "Trump trade" in 2025 and beyond.