A New Term
November 11, 2024
Congratulations to President-elect Donald Trump. Based on the economy he is inheriting, he has his work cut out for him.
Before I contrast the stark differences between the expanding economy of 2016 and the cooling economy of 2024, let's look at the political challenge of the divided House. It is marginally true that Republicans will have 'control' of the house, with the slimmest of majorities. However, it is also true that the Republicans already have control of the house, but they have been so divided that speaker Mike Johnson has only been able to pass budgetary legislation with the help of many Democratic votes. Since all budget bills must originate in the house by law, the challenge for Trump to extend or expand his previous tax cuts is to first get legislation through the House.
In 2016, the Republican majority was 23. Of these, 13 Republicans defected and voted against the tax cuts, leaving a slender 10 count majority.
Today the Republican majority is 4, pending final election results. It just gets a lot harder to pass legislation with such a slim lead, hence Mike Johnson's continued compromises with Democrats. Remember John McCain's famous thumbs-down vote which saved Obamacare. The spoiler this time around is likely to be the SALT Caucus.
The SALT Caucus is a bi-partisan group of congresspeople (23 Democrats, 10 Republicans) who represent the only people in America who actually pay more taxes because of Trump's tax cuts. These are wealthy homeowners in California and New York, who lost the valuable State and Local Tax (SALT) deduction as a result of Trump's 2017 tax law. They have promised not to extend the Trump tax cuts in their current form, and this belief is so central to their political lives that they created a caucus to defend it. Without them, there simply aren't enough votes to pass any kind of budget legislation, including through the reconciliation process.
In all likelihood, President Trump will get some sort of tax legislation enacted. He will offset some of the cost by ending some of the spending enacted by President Biden (subsidies for clean energy, electric vehicles, etc). Given the near-tie in the House of Representatives I believe that the ultimate tax legislation will look more purple than ruby red.
After President Trump successfully negotiates a compromise bill with the divided house, then comes the hard part. The economy he inherits today is vastly different than the one he faced in 2016. Here are some key numbers that I put together, contrasting Then and Now (Then is November 2016, and Now is November 2024).
Politics aside, these numbers are the real problem facing President Trump as he looks to lower taxes and spur growth. If our economy is a big ship, in 2016 he inherited a big ship that was slowly cruising in the right direction. His tax cuts helped increase the speed. Today, the ship is going in the totally wrong direction, and he has to figure out a way to turn it around without spilling or breaking anything. It's just hard to do.
Today the 30 year mortgage rate is almost double what it was Then, up from about 3.5% to almost 7%. The housing market is shrinking rather than expanding. In the 12 months preceding the 2016 election, the unemployment rate had declined by almost 8% - and it continued to decline under Trump's presidency. In the 12 months preceding the 2024 election, the unemployment rate has risen by almost 11%, and looks likely to continue rising for the foreseeable future.
The Fed continues to slam on the brakes. The Fed Funds rate was practically 0% back Then, basically free money. Today it is a hair below 5%. Industries that rely on financing to survive are struggling. Stellantis, the former Chrysler auto group, is laying off employees and taking drastic moves to shore up it's balance sheet. Ford is also beginning layoffs and slowing production. High interest rates are a powerful brake on the economy.
Finally, in 2016, the interest cost of government debt was just 1.3% of GDP, or $241 Billion. Today, the government spends $1 of every $5 of tax revenue simply making the interest payments on debt. Let that sink in for a minute. 20% of your tax dollars are simply paying interest. The interest payments are 3.9% of GDP (triple the amount from 2016), and the dollar cost is well over $1 Trillion annually.
If any new tax legislation increases the deficit by too much (and the financial markets will decide what 'too much' means in dollar terms, not the Democrats or Republicans), the 30-year mortgage could move from around 7% today to 8 or 9 or 10%. Car loan rates would jump, crushing sales and resulting in mass layoffs at the automakers. If that sounds like a recipe for recession - it is.
If any new tax legislation doesn't do enough to stimulate the economy, then unemployment could continue to rise and high interest rates will continue to slow the economy.
President Trump has an unenviable job. Politics aside, I think whoever won the presidency in 2024 was going to inherit some sort of recession, or at least a cooling period. The debt hangover from pandemic is just going to take some time to wear off. I believe the best is behind for the stock market. It seems counter-intuitive as the government borrows, but as growth slows, money will be forced to move from stocks to bonds, keeping a lid on yields. I continue to favor bonds over stocks. The unemployment rate is the key number to watch here - as long as it keeps creeping up, I believe a more conservative portfolio outperforms a more aggressive portfolio. Obviously, I include all the standard disclaimers. I have no crystal ball, all of this is just my opinion. The best investment remains a nice walk with a friend, drinking water, or just turning off the TV.
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Naylor Asset Management is a Registered Investment Advisor in the state of Minnesota.