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THE U.S. STOCK MARKET has historically delivered similar returns under both Democrat and Republican administrations. For that reason, my view is that investors shouldn’t worry too much about who occupies the White House, and I tend to stay away from investment discussions that involve politics.
But sometimes, the news coming out of Washington dominates the headlines in a way that can’t be ignored. Such is the case today. Moreover, with the stock market faltering recently, investors have been asking questions about the new administration’s policies and wondering how they might respond.
To think through this question, we can start with a closer look at the two policies that have received the most attention: the imposition of higher tariffs and the creation of a new cost-cutting department under the leadership of Elon Musk.
Tariffs raise a number of concerns. Most obvious is that they could result in higher prices for American consumers. Some consumers are already stretched thin by the recent spike in inflation, and further price increases would be unwelcome.
On top of that, tariffs can have broader implications for the economy. When prices are higher, people can’t afford as much, and that can cause the economy to slow. When the economy slows, corporate profits fall and that, in turn, can lead to lower stock prices.
In addition, there’s the risk that other countries could retaliate in response to U.S. tariffs, imposing their own tariffs on American goods. That could hurt domestic manufacturers. It’s for all these reasons that economists are nearly unanimous in seeing tariffs as a bad idea.
What about the new Department of Government Efficiency (DOGE)? This initiative too is raising concerns because it seems to be focused primarily on reducing government headcount. Since the federal government employs about three million people, the worry is that significant cuts could materially affect unemployment.
Compounding that would be a dynamic economists call the multiplier effect. When people lose their jobs, they aren’t able to spend as much, and that can lead to a slowing of the economy. They might also sell their houses, leading to downward pressure on home prices. A further concern is that, if the government workforce is cut too significantly, critical services might be impacted.
That, I think, summarizes the key concerns around these new policies. The question, though, is how to respond, and that’s the hard part. It’s hard because the negative scenarios I described above are all realistic but not necessarily guaranteed.
The use of tariffs, for example, could end up being temporary and just a negotiating tactic to achieve political aims with other countries. If that’s the case, then there would be little, if any, inflationary impact.
Even if higher tariffs were put in place permanently, they aren’t guaranteed to cause the spike in inflation that many fear. That’s the view of Scott Bessent, the new U.S. Treasury secretary, who explained the administration’s thinking in a recent interview.
Even critics of the administration have argued that higher tariffs may result in only modestly higher inflation. In November, Alan Blinder, an economist who served in the Clinton administration, wrote an opinion piece that carried the headline “Trump’s Economic Plan Has Inflation Written All Over It.” But when he broke down the math on prospective tariffs, his conclusion was that consumer prices might rise, at most, by 3%. And Blinder notes, it would be a “one-shot price increase.”
Similarly, DOGE’s efforts to cut back on the federal workforce may not have the negative impact that many fear. To be sure, the impact is negative for those who lose their jobs, and I don’t minimize that. DOGE’s objective, though, is to reduce the government’s annual deficit, which has reached alarming levels in recent years. Reducing the deficit would help bring down interest rates. That would benefit both the government as well as everyday consumers. And since interest payments now account for one-seventh of the federal budget, the impact of reducing interest rates could be considerable.
In short, the ultimate impact of these new policies is not a foregone conclusion. Proponents and opponents each have their own views, but it’s too early to know for sure how the administration’s policies will affect the economy now and into the future. As you think about your own portfolio, you may find the following analogy helpful.
Nassim Taleb, author of The Black Swan, compares investment markets to a pool table. When you hit the first ball, you can be pretty sure where it’s going to go. A skilled player might even be able to control what happens when that first ball hits the next one. But beyond that, it’s anyone’s guess. Things are just too random.
That image, I think, does a good job illustrating the dilemma investors face today. It’s hard enough to know what will happen in the short term. It’s even harder to know what will happen in response. And it’s nearly impossible to know how that will all net out to affect investment markets a year or two or three from now. And thus, it’s nearly impossible to know what action an investor should take.
That might sound like an unhelpful conclusion, but the good news is that we don’t need to be able to see the future to guard against negative outcomes.
Instead, this is the approach I recommend: As a thought experiment, let’s assume that all of the negative predictions are borne out—that the tariffs and cost-cutting do result in a recession and a stock market downturn. If we assume that these negative outcomes are guaranteed, investors can then ask themselves a question which is, I think, much easier to answer. How should my portfolio be positioned for a market downturn?
The good news: This is a question that investors should always be asking themselves. It has, to a great degree, a straightforward answer: An investor’s best defense is asset allocation and diversification. If you have sufficient resources outside the stock market—in some combination of bonds and cash—you should be well positioned to weather even a multi-year disruption to the market.
Adam M. Grossman is the founder of Mayport, a fixed-fee wealth management firm. Sign up for Adam’s Daily Ideas email, follow him on X @AdamMGrossman and check out his earlier articles.
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If there was serious crash, some conservative stocks would be available at a low price, and I would be buying them.
But I don’t think things will get bad enough for that to happen.
Adam, what about tax cuts, exempting some income from tax, making SS tax free, all with a $2 trillion deficit and faltering Social Security and Medicare trusts?
One word. “Plastics”!
Nice summary Adam. Ideally, we purchase appropriate levels and types of insurance when times are calm. That is also the time to implement asset allocation and diversity in our investments. When turbulent times and market volatility arrive, there is no action needed, apart from rebalancing.
In 2022 my Right friends bemoaned the lousy state of the market, today my Left friends are beginning doing the same. I may or may not like what goes on in Washington at any given point, and my opinions are, well, just mine, as are yours. Is my leader dumb like a fox, or just dumb? To borrow a thought from Aaron Burr in the musical Hamilton, I’m not “in the room where it happens”, so I don’t know what I don’t know.
I think I’ll follow Newsboy’s recommendation below.
Yours is a voice of reason, Adam, thank you. If only more of us would try to seek understanding, instead of spouting opinions, we might find solutions that are beneficial to all.
OOPS, see below. 😳
For those who’ve dogmatically committed to proper asset allocation and diversification, the words of Jack Bogle still ring true in times such as these:
“Don’t just do something – stand there!”
Exactly. Benign neglect will do wonders for your portfolio.
Great reminder, Adam. I have an opinion about the policies in Washington, but no one has asked me for it, and I’m not a player. I have just a smidge more influence on what happens there as I do over a ball game on television. But I can be vigilant with my own financial life with just a few clicks on my computer.
“I have just a smidge more influence on what happens there as I do over a ball game on television.”
Yeah Ed, but don’t you still yell to the players shoot, pass, or watch out? Or when watching Jeopardy blurt out the answer, and then when two contestants answer incorrectly keep blurting out your answer? Or maybe that’s just me. If others don’t do that maybe that’s why my wife gets irritated with me.
You caught me David!