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Economic Forecasts

The Trump Effect on Financial Markets

Faster growth and lower taxes compete with inflation and higher rates.

illustration by Nigel Buchanan

Given the rally in the stock market following the U.S. presidential election, you’d think the investment implications of a Donald Trump administration were clear. They’re anything but. Policy specifics will likely remain scant until federal budget proposals surface this spring, and it’s not certain what will come to fruition. Trump’s proposals likely would produce financial markets with several crosscurrents—some positive, some not (or positive at first, but then less so).

See Also: Protect Your Retirement Nest Egg During the Trump Rally

For now, the honeymoon will continue. Stocks are up on the potential for a boost in economic growth and corporate earnings stemming from spending on infrastructure, lower tax rates, reduced business regulation, and buckets of corporate cash repatriated from overseas. “The market has assumed we elected pro-growth, tax-cutting, roll-back-regulation Donald Trump, and not tariff-oriented Donald Trump,” says Bob Doll, chief stock strategist at Nuveen Asset Management. Eventually, Doll believes, “we will hear from protectionist Donald Trump, and the market won’t like that.” Meanwhile, accelerating growth presents the challenges of rising interest rates and higher inflation, which will temper the Trump rally and cap gains at year-end to mid-single-digit percentages, say Goldman Sachs strategists.

Economy-sensitive stocks will lead. Already up sharply, so-called cyclical stocks may climb higher. Goldman Sachs economists expect Congress to pass a fiscal stimulus package consisting of $100 billion in tax cuts and $50 billion in infrastructure and other spending per year, boosting gross domestic product growth by 0.6% over two years. And every one-percentage-point reduction in corporate tax rates—the top federal rate could plunge from 35% to somewhere between 15% and 25%—could add another $1.50 a share to S&P 500 earnings, say strategists at UBS Securities.

In such a climate, bargain-priced stocks will have an edge over those of faster-growing companies; small-company stocks could edge out bigger brethren. Goldman recommends shares of companies that generate most of their sales in the U.S. and pay high tax rates, including Charles Schwab (symbol SCHW, $39) and Lowe’s Cos. (LOW, $71).

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Buybacks, dividends and mergers could surge. S&P 500 companies (not including financial firms) hold some $1.1 trillion overseas, says UBS. If that money were repatriated and taxed at a rate of 8.75% (previously suggested by Republican lawmakers), the windfall would amount to close to $300 billion, of which 75% could go toward share buybacks, dividends, acquisitions and spending on workspace or equipment.

Fear could triumph over hope later in 2017 as worries about rising rates, higher inflation and trade tariffs escalate—especially if congressional deficit hawks constrain tax reform, says Goldman. In­vestors would then want companies that can prosper when inflation and rates are headed up. Look for firms with low labor costs and great balance sheets, says Goldman, such as Visa (V, $77) and Costco Wholesale (COST, $150).

It’s likely the end of an era for bonds. Yields on 10-year Treasuries have already jumped from 1.7% this past summer to 2.4%. “That’s the end of the 35-year bull market in bonds,” says Doll. “Done. Finished. Kaput. Bury it.” Bonds remain important for income and diversification, but tilt toward high-quality issues with short maturities and favor Treasury inflation-protected securities (TIPS), says Darrell Cronk, of Wells Fargo Investment Institute.

See Also: A Preview of the Fed Under Trump