With the Fed on hold and President Donald Trump anxious to wrap up his trade wars, the Dow Jones is rebounding from a punishing correction. But political risk looms large in the stock market outlook.
Heading into the 2020 election, political friction will be impossible for the stock market to tune out. The Robert Mueller Russia probe is wrapping up, with House Democrats eager to consider a Trump impeachment. Meanwhile, left-wing presidential hopefuls want to reverse tax cuts and then hike taxes as part of a sweeping agenda.
Americans have grown accustomed to high-decibel politics. But as far as the stock market outlook is concerned, we’re actually leaving behind a period of relative tranquillity. Wall Street cheered Trump’s pro-business tax cuts and deregulation, despite serious concerns over trade and Trump rhetoric.
No president ever used the Dow Jones as a scorecard of success quite like Trump, so don’t expect Democrats to help prime the pump further heading into the 2020 election. The balmy fiscal tailwinds of tax cuts and lax spending are about to turn into a modest headwind for the economy and the stock market outlook.
Trump’s own unpopularity and diminishing 2020 election prospects could undermine the economy and stock market, creating a negative feedback loop.
Trump, Economic Outlook, Stock Market Outlook Linked
A divisive Trump impeachment battle could hurt the president’s 2020 election hopes and put his business tax cuts at risk. And if Trump job approval numbers sag much further, Democratic presidential contenders’ plans to reverse the Trump tax cuts and spread the wealth will look all the more worrisome to CEOs, entrepreneurs and investors. These trends could reinforce each other, sandbagging business sentiment, the economy, Dow Jones and the Trump 2020 election bid.
“We can now begin to see that the wealth gap issue will probably be the biggest issue of the election,” Ray Dalio, founder of hedge fund behemoth Bridgewater Associates, wrote on LinkedIn.
“This will become increasingly apparent,” Dalio wrote, highlighting emerging Democratic plans for a 70% marginal tax rate and wealth tax. “We know these things will have big implications for capital flows, market valuations, economic conditions, and domestic and international relations.”
Business and investors may not be ready to pull back based on tax changes that may or may not happen after the 2020 election. Yet with the economic outlook already becoming clouded, a rise in political uncertainty could erode economic optimism. Further slippage in Trump’s approval, whether due to a softer economy, fallout from his fight for a border wall or a Trump impeachment battle, could dim the stock market outlook long before Election Day.
Trump Trade War, Fed Fears Fade For Stock Market
Trump’s China trade war and Fed interest-rate hikes took center stage in 2018 and tripped up the long bull market late in the year. Yet the stock market swoon appeared to clear the deck of those risks to corporate earnings and the economy.
Officially, U.S. tariffs on $200 billion in Chinese imports are set to jump from 10% to 25% if there’s no deal by March 1. Trump has come close to saying that the risk of escalation is off the table. “This is either going to be a very big deal, or it’s going to be a deal that we’ll just postpone for a little while,” he said on Jan. 31.
But the stock market outlook would quickly sour if China talks break down and Trump tariffs escalate vs. Beijing. The Dow Jones fell Thursday as White House economic adviser Larry Kudlow said Washington and Beijing are still far apart on a China trade deal. Trump said he wouldn’t meet with President Xi Jinping before March 1, implying no China trade deal this month but also no tariff escalation
Trump trade wars already have contributed to a slowing Chinese and global economy. That damage won’t be quickly reversed.
As for the Fed, gears shifted almost overnight. After expecting two rate hikes this year as of Dec. 19, Fed Chairman Jerome Powell turned dovish on Jan. 4, sparking a follow-through day for the stock market rally. By Jan. 30, the central bank officially abandoned its endorsement of “some further gradual increases” in Fed rate hikes.
Despite a risk of global auto tariffs, which Trump could embrace later this month, trade war and Fed risks likely will re-emerge only if the stock market and U.S. economy have a strong 2019. Other political risks, on the other hand, likely will grow if the economy underperforms.
Trump Border Wall Fight
Waging a battle over his border wall, Trump seems perched at a precarious spot. Trump’s underwhelming 42.2% job approval rating, based on the RealClearPolitics average, has deflated toward the lower end of its range since the economy took off in the spring of 2018. Falling below 40% would make a Trump 2020 election victory a steep uphill climb, and he seems to realize it.
Polls show Americans blamed the record government shutdown on Trump, who tried to use it to force Congress to fund the border wall. But he can’t afford to alienate his base.
“If I did something that was foolish, like gave up on border security, the first ones that would hit me are my senators,” Trump has said. “The second ones would be the House. And the third ones would be, frankly, my base.”
The shutdown didn’t derail the current stock market rally, which began a few days into the border wall standoff. But with short-term government funding due to expire Feb. 15, another shutdown is possible.
In Trump’s State of the Union address Tuesday night, the president claimed a “moral duty” to build a border wall with Mexico. “I will get it built,” he vowed.
Trump could declare a national emergency to fund the wall, but that would face legal challenges and congressional opposition.
The president also has hinted that he sees the border wall fight as the undercard to a coming Trump impeachment battle.
“Well, you can’t impeach somebody that’s doing a great job,” Trump declared on Jan. 4. “That’s No. 1.” Although Trump again adamantly denied any collusion with Russia, that was a secondary defense.
Robert Mueller Russia Probe
Special Counsel Robert Mueller is expected to submit his Russia investigation findings fairly soon. It’s unclear how close indictments and allegations will get to the White House. But if they are close, you can expect Democratic calls for Trump impeachment.
The GOP-led House impeached President Clinton in December 1998 while the Republican Senate acquitted him in February. The stock market shrugged off that political fight, surging from October 1998 to the March 2000 dot-com peak.
Trump Impeachment And Stock Market Outlook
Would a Trump impeachment be different?
Trump, in the State of the Union, said “ridiculous partisan investigations” could threaten the economy.
Back in August, when stocks were close to their peak, he said, “If I ever got impeached, I think the market would crash, I think everybody would be very poor.”
That’s a huge exaggeration. Yet numerous market and economics commentators dismissed Trump’s boast a little too easily. After all, business confidence did soar along with the stock market after Trump’s election transformed gridlock into unified political control by the tax-cut-loving GOP. After cracking 18,000 in December 2014, the Dow Jones went almost nowhere before Trump’s surprise victory. The Dow then surged past 26,000 over the ensuing 14 months.
With a Trump impeachment, assuming the GOP-led Senate didn’t convict, concerns about the stock market outlook likely would revolve around Trump 2020 election chances.
The stock market has not fared well since the tax cuts took effect, largely because the Dow Jones rallied in 2017 in anticipation of tax reform. Also, the earnings outlook has dimmed somewhat amid Fed tightening, trade conflict and a global economic slowdown. Stock prices would be lower without the Trump tax cuts, which reduced the average effective tax rate for S&P 500 companies by roughly one-third.
Will Democrats Win Senate Majority In 2020?
“Trump’s chances for re-election are pretty iffy,” said Stephen Gallagher, U.S. chief economist at Societe Generale. Yet “the Senate would have to swing to Democratic control” to imperil his 21% corporate tax rate.
A weak Trump, softer economy and a modestly favorable map for Democrats in the 2020 election could open the door for unified Democratic control of Congress. The PredictIt political betting site sees a close battle for Senate control, with roughly 43% odds that Democrats will win.
While a Trump impeachment and, especially, a Senate conviction are unlikely, investors still must guard against the risk that the Mueller Russia probe report will further damage the president and the GOP’s Senate majority.
If the Mueller probe report is especially damaging, Wall Street will have to start factoring in the risk that Democrats will be able to repeal the Trump tax cuts after the 2020 election. That would have significant implications for future corporate earnings and the stock market outlook.
Democrats’ Left-Wing 2020 Election Agenda
Repealing Trump tax cuts is just one step. Left-wing Democrats led by rock-star freshman Rep. Alexandria Ocasio-Cortez are calling for 70% marginal tax rates on the wealthy. Sen. Elizabeth Warren, D-Mass., a 2020 presidential contender, just rolled out a wealth tax plan estimated to raise $2.75 trillion over a decade. That would be a heavy tax on investors.
A tussle over tax policy is inevitable. The budget deficit is already on track to hit $2 trillion within a decade. Neither party has the appetite to rein in Social Security and other entitlement programs. With this backdrop, not even the magic of Modern Monetary Theory will finance Democratic spending plans.
California Sen. Kamala Harris, who is also running for president, tweeted recently that she will partly pay for her 2020 election agenda — Medicare for All, universal pre-K, debt-free college and a wage supplement of up to $500 per month for middle-class households — “by reversing this Admin’s gifts to big corporations & the top 1%.”
Democratic lawmakers, including Ocasio-Cortez, unveiled a Green New Deal resolution on Thursday, endorsed by Kamala Harris. The resolution envisions sweeping environmental regulation, massive income redistribution and heavy state-planning of the economy. Even without legislation, a Democratic president likely would adopt a pro-regulation agenda that could damage corporate profits and the stock market outlook.
Although big policy changes would be years away, the fiscal cloud hanging over the U.S. economy could exert a downward pull sooner than later. Rising political uncertainty, slow growth and weak stock markets could speed up inevitable state and local government pension crises.
Stock Market Surprise In 2019?
None of these concerns has grabbed the attention of Wall Street so far. That could set the stock market up for a negative surprise. Most Wall Street strategists’ stock market outlooks have been bullish after the Dow Jones and other major averages fell in 2018. They note that the third year of a presidential cycle is typically the best for a stock market rally, with double-digit percentage gains.
Yet 2011 was something of an exception, with a slim 1% rise. The political backdrop shared a few key similarities with today. President Obama’s big 2009 stimulus had faded, and the GOP had seized control of the House in the midterm elections. Republicans did their best to hit the fiscal brakes. They even precipitated a debt-ceiling standoff that cost the U.S. its ‘AAA’ debt rating from Standard & Poor’s.
Fiscal Headwinds For 2020 Election
Democrats aren’t about to push for deficit reduction. But House Democrats’ recent backing of PayGo rules suggests they’d demand painful trade-offs that would derail any infrastructure program or tax cuts.
Federal spending faces a “mini-cliff” in October with the start of fiscal 2020, says Gallagher. Discretionary spending caps are set to automatically fall by $126 billion. Gallagher doesn’t expect much of a spending drop. Yet gridlock partly explains Societe Generale’s forecast that GDP growth will slip to about 1% by year-end. The firm expects a recession in the first half of 2020.
As global growth slows, rising political uncertainty that dampens investor and business sentiment would put more pressure on the U.S. economy and the stock market outlook.
That would imperil Trump tax cuts, which he promised would create a long-lasting economic boom. There were sound policy reasons for making the U.S. corporate tax code more competitive, and wage growth has perked up. Yet Democrats will have a field day if the good economic news begins to slip away.
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