The Election and the Economy

Following the surprising election of Donald Trump and the news that Republicans had held on to the House and Senate, the stock market rallied. Optimism on near-term economic growth may be warranted, but investors should also be realistic. Growth over the next couple of years will be restrained by the demographics (slower labor force growth) and fiscal stimulus is more likely to fuel inflation and boost long-term interest rates.

Heading into Election Day, polls had suggested that Hillary Clinton would likely win enough Electoral College votes to gain the presidency. However, given the uncertainties in polling results and turnout, Donald Trump still had a path to victory. It boiled down to the key battleground states. He won Ohio, where polls had had him ahead. He won Florida and North Carolina, where the two candidates had been polling neck and neck. That left him with a good chance to win if he could flip one of Hillary’s “firewall” states, Pennsylvania, Michigan, or Wisconsin, where she had been polling ahead in each. He won Pennsylvania and Wisconsin (and likely Michigan), lifting him over the 270 Electoral College votes needed.

A couple of weeks before the election, Democrats appeared to have a strong chance of regaining control of the Senate. The Republicans were defending 24 seats this year. The Democrats were defending 10 and needed to pick up four seats (five if Trump won). They led in six of the Republican-held states, but that faded as the election neared. Instead, Democrats flipped just two seats, leaving control with the Republicans, who also retained control of the House of Representatives.

With Republicans controlling both chambers of Congress, President Trump should be able to achieve much of what he wants. And with Trump in the White House, congressional Republicans should be able to get most of what they’ve wanted, including the repeal of the Affordable Care Act.

Interestingly, we’re now hearing talk of fiscal stimulus (tax cuts or additional spending to spur growth). Trump, like Hillary, promised more infrastructure spending during the campaign. However, getting that through Congress may be tough. The House no longer has earmarks, which makes it difficult to reach a broad agreement on additional spending. Moreover, members of the Freedom Caucus, an extension of the Tea Party Republicans, are expected to resist more spending.

The one area on which all can agree is tax cuts. The nonpartisan Tax Policy Center estimates that Trump’s proposed tax cuts would reduce federal revenues by $6.2 trillion over the next 10 years, and with the added interest expense, would add $7.2 trillion to the national debt. However, it’s widely expected that tax cuts will be scaled back from what was promised. The economy is already close to full employment. Hence, large-scale tax cuts may be more likely to fuel bubbles.