Trump’s messy governing challenges

The year started with a bang. Investor hopes were high on the expectation of the implementation of Trump’s pro-business and pro-growth policies, but stock prices struggled and ended last week in the red.

According to FactSet, the bottom-up aggregated S&P 500 target price for year-end 2025 is 6,678.18. But in the last 20 years, bottom-up analysts have historically overestimated the S&P 500 year-end price by 6.9%. Applying the 6.9% discount we would arrive at an adjusted target of 6,084.19, which represents a price gain of 5.7% for the year.
 

 

The FactSet adjusted estimate is roughly in line with my expectation of low single-digit gains. Along the way, however, I expect a higher degree of market volatility during the year as the Trump 2.0 Administration takes office and faces the challenges of governing.
 

Here’s why.
 

 

The challenges of governing

Donald Trump was elected as a disrupter. Washington needed to be disrupted, and Trump was the man to do it. However, the details of disruptions were less clear. In many ways, we can draw an analogy with Brexit. Brexit was seen as a new order for Britons, though there was no consensus on the actual details of Brexit implementation. The reality of Brexit turned out to fall short of the expectations of most Brexiteers.
 

In the same fashion, Trump will have to face the challenges of governing.

The recent dispute within the Republican Party over the H-1B visa is an illustration of the hard choices of governing. For readers who are unfamiliar with the H-1B visa, employers apply for H-1B work permits for overseas skilled workers, but those workers are severely restricted from leaving their employers once they landed on U.S. soil. Employers argued that there was a lack of trained U.S. personnel to fill open positions. Trump’s electorate base argued that the H-1B undercut American workers. The truth was somewhere in between. There is a lack of qualified skilled workers at a price, and H-1B visas helped employers, which are mostly technology companies, to improve their margins with lower labour costs.
 

In the end, Trump sided with the employers.
 

 

 

Legislative challenges

As Trump takes office on January 20, here are some of the challenges facing him.

The most immediate challenge was the election of a Speaker of the House. The current speaker, Mike Johnson, faced a number of challenges to his position. The Republicans hold a 219–215 majority. Rep. Thomas Massie (R-Ky) has actively opposed Johnson, which means that one more Republican defection would sink Johnson’s leadership. In the end, Johnson won the speaker’s gavel on the first ballot after some extensive negotiation. This was a test that turned out to be bullish for the Republican legislative agenda, but the risk of a Party revolt was extensive.

The next urgent issue facing the government is the debt ceiling. Trump had hoped that the last-minute continuing resolution deal in December to avoid a government shutdown would extend or eliminate the debt ceiling, but his hopes were dashed. On December 27, Treasury Secretary Janet Yellen wrote to Congress and warned, “Treasury currently expects to reach the new limit between Jan. 14 and Jan. 23, at which time it will be necessary for Treasury to start taking extraordinary measures.”

In the short run, Treasury’s “extraordinary measures” are equity bullish, as it draws down the funds in the Treasury General Account held at the Fed. This has the effect of writing cheques and injecting liquidity into the banking system, which is bullish. If the debt ceiling dispute isn’t resolved in reasonably short order, the market will start to price in the tail-risk catastrophe of a U.S. Treasury default.
 

 

 

Bessent’s Challenges

As well, incoming Treasury Secretary Scott Bessent faces the challenge of re-financing about 30% of the $28 trillion of the Treasury’s outstanding debt. The Yellen Treasury adopted the position of issuing a greater mix of short-term T-Bills, which are effectively floating rate paper, compared to fixed-rate coupon paying Treasury Notes and Bonds. As rates have risen over the past few years, the reliance on short-term financing has increased the Treasury’s interest burden.
 

Bessent has promised to remedy the situation by borrowing longer term. But the issuance of long-term debt has the short-term effect of draining liquidity from the banking system. To explain, imagine an investor has the option of investing in short-term paper, which he can draw on relatively quickly, or lock up his money in a long bond, which is less liquid and comes with price risk. As a result, a greater pool of short-term Treasury paper encourages higher banking system liquidity, which is equity positive.

A Bloomberg article, “Treasury’s Elite Bond Dealers Will Struggle to Handle $50 Trillion Debt”, outlined the extent of the challenges facing the new Treasury Secretary. One stark example occurred last September, when Citadel Securities announced in September that it declined to join the group of Treasury primary dealers, which makes a market and bids on newly issued Treasury securities. Bloomberg reported that heavy issuance was putting strains on primary dealer operations:

“Issuance has gone up almost threefold in the last 10 years and the anticipation is for it to close to double to $50 trillion outstanding in the next 10 years, whereas dealer balance sheets haven’t grown at that magnitude,” said Casey Spezzano, head of U.S. customer sales and trading at primary markets dealer NatWest Markets and chair of the Treasury Market Practices Group, the government-debt watchdog sponsored by the New York Fed.

Macro headwinds

Trump’s policy challenges could have the effect of distracting the incoming administration from implementing its equity friendly policies of tax cuts and deregulation. In addition, stock prices face a number of macro challenges in the year ahead.

First, disinflationary progress appears to be stalling. The inflation expectations factor, as measured by a long TIPS ETF and short long zero-coupon Treasury ETF, is breaking out to new recovery highs. The Fed may soon face a difficult decision of either accepting a higher 3% inflation rate or raising interest rates.
 

 

At the same time, economic growth may be stalling as the U.S. Economic Surprise Index has declined in the past few months. While these readings are not recessionary, they do raise the risk of either stagflation or recession scares later in the year. Decelerating economic growth rates also translate into falling earnings growth rates, which is equity bearish.
 

 

These macro risks are occurring against a backdrop of an elevated forward P/E ratio. The S&P 500 is priced for perfection, or near perfection.
 

 

In conclusion, I reiterate my belief that in the absence of a recession the S&P 500 should register low single-digit gains for 2025. However, the emergence of policy implementation risk by the incoming Trump Administration makes me believe the market will experience several volatility shocks during the year. Be prepared for a choppy but mildly positive year for stock prices in 2025.