Trump 2.0: Using Objective Investing Models to Guide Us Through Anticipated Disruption

A second Trump administration appears poised to bring big changes. The precise mix and sequencing of those changes will likely determine the economic and market outcomes that result. In this month’s cover article, we walk through several of the most prominent policy proposals and discuss what investors should watch for.

SMI places little value on forecasting. In contrast to a forecast-driven investing plan, SMI teaches that investors should instead direct their effort into building a robust portfolio constructed intentionally to be able to withstand a wide variety of market conditions. If you’re following a blend of the SMI strategies, that’s exactly what you’re doing, intentionally or not.

That’s not the same thing as saying your portfolio shouldn’t change in response to market conditions. However, rather than trying to predict those changes, SMI’s strategies are built on trend-following principles. These strategies will methodically and mechanically adjust our positioning, and by extension, our portfolio risk. But they’ll do it in response to market trends already in motion rather than predictions of what seems likely to happen six to 12 months in the future.

That said, we do think there are occasions when SMI readers are interested in our thinking as to what the prevailing investment winds are likely to be in the coming months. With that in mind, let’s briefly review 2024 and then turn our attention to the main focus of this article — the expected Trump 2.0 policies and what to watch for, not just in 2025 but in the years ahead.

There’s an old market saying that “bull markets don’t die of old age.” (The phrase “they’re murdered” is sometimes added to the end of that, and often “by the Fed” is attached as well.) The point is simply that you shouldn’t get nervous just because a bull market has lasted a while, as most bull markets end due to a specific catalyst. Of course, every rule has exceptions, but normally those catalysts fall into one of two (often connected) groups. Bull markets normally end due to rate hiking cycles or recessions. Interest rate hikes are unlikely At present, despite strong economic growth, inflation running above the Fed’s target, and low unemployment, the Fed is bending over backward to lower rates. Rate hikes murdering the current bull market is not an immediate concern; quite the opposite, we have a hyper-reactive Fed desiring to cut rates, primarily to make housing (and the massive government debt) more affordable. If rate hikes are unlikely as a 2025 bull market murder weapon, what about recession? The risk of a recession

This is where the experience of the past two years comes in handy. Investors and economists have had to repeatedly eat humble pie as one “never before” indicator after another has failed. However, this isn’t about reflexively leaning the opposite way after having seen recession predictions repeatedly fail in recent years. Rather, it’s recognition that the global economy and markets changed following COVID and the resulting massive government spending response by countries around the world.

Nowhere was that more true than in the U.S., where the federal government enthusiastically engaged in historically high peace-time spending post-COVID. As evidenced by years of record budget deficits, once that genie is out of the bottle, it’s really difficult to stuff it back in.

To state our recession view succinctly, it’s hard to have a recession when nominal GDP is growing at 6% (the inflation-adjusted growth of the economy is 3.3% and inflation is currently 2.7%). Add to this 1) the federal government is running a deficit of 7.2% of GDP, 2) the Fed is already cutting interest rates, 3) unemployment is historically low, and 4) business and personal balance sheets are collectively stronger than they’ve been in decades.

When the odds of an oncoming recession are as low as they appear to be at present, it’s generally not a good idea to position a portfolio for it pre-emptively. Even if a recession were to surprise us, SMI’s mechanical trend-following strategies are designed to respond and help protect us. Given the current setup, investors are more likely to miss out on gains by fearing a near-term recession than they are to suffer losses as a result of being caught off guard by one.

Remember, most of the deep losses that hurt investors come during recessionary bear markets. Years without recessions often include a market correction of 8-15% at some point, but those are typically counterproductive to try to position for in advance. That type of correction sometime during 2025 seems like a reasonable expectation. Today’s euphoric investor sentiment coupled with presidential cycle year-one seasonality (that often sees the market decline early in the year) may argue in favor of such a market correction occurring during the first half of 2025.

Trump 2.0

A good reason for carefully thinking through the growth/recession landscape is to provide a framework for the Trump 2.0 policy discussion that follows. Could some combination of Trump’s new policies change the facts on the ground and end this bull market? Of course. But we should be thinking about those changes in terms of “Are they significant enough to cause a recession, and over what time frame?” That’s where the bear market risk lies.

President-elect Trump’s second term carries the potential for change on a scale that today’s investors have never seen. It’s a daunting task to sort through the potential implications of these changes — in part because we don’t even know yet which of these changes will ultimately be implemented or how the sequencing will play out. Before diving in, a quick disclaimer that none of what follows is intended as commentary on whether these policies are good or bad. I’m trying to focus on what seems likely to be done and the economic and investment impact of those actions. Disruptor in Chief

Investors’ response to Trump’s re-election was immediately positive. Some of that was likely just relief over the worst-case contested election scenarios having been avoided. But gains continued into December, and other data points corroborate investor/business enthusiasm. For example, the Dec. 10 small business optimism survey exploded higher to levels unseen since the Covid economy re-opened in 2021. Small businesses are probably the best measure of “Main Street” business sentiment, and they are excited about the prospects of Trump’s second term.

While it’s easy to see why investors and business people might be excited over the traditional conservative aspects of a Trump 2.0 term — tax cuts, deregulation, lower energy costs — we shouldn’t forget those policies weren’t the primary focus of Trump’s campaign. In many respects, Trump is the antithesis of traditional Wall Street/globalist thinking — the benefits of free trade. He believes these policies have been the root of many of America’s problems, and his appeal for many lies in his promise to at least disrupt, if not completely dismantle, the global free-trade system erected over the past 30+ years.

This goal is audacious enough that it seems Wall Street doesn’t believe he’ll actually follow through on it. During Trump’s first term, there was a popular idea that we should take Trump “seriously, but not literally.” In other words, Trump is always negotiating and looking to make a deal. So if he threatens huge tariffs, it’s not that he actually intends to impose them, but rather it’s a negotiating tactic to get what he really wants. And in fairness, there were plenty of examples of that during his first term.

While that was largely true of Trump 1.0, there are plenty of clues that Trump 2.0 has a different playbook in mind. Global free trade has been great for capital (and by extension, investors). For decades, companies have lowered their costs by hiring cheaper labor overseas while enjoying more growth by accessing new markets. Corporations (and investors) have profited greatly while labor’s share of those profits has steadily declined. Trump 2.0 appears to be more focused on ending this trend, prioritizing workers over owners’ profits and reversing what he perceives as the longer-term individual and societal fallout from these policies.

Up to now, Wall Street appears to be focused on Trump’s “business-friendly” policies. His choice of Scott Bessent as Treasury Secretary with his “3-3-3 plan” — targeting 3% economic growth, reducing the deficit to 3% of GDP, and pumping an additional 3 million barrels of U.S. oil per day — was cheered by investors. Bessent is a highly decorated investor and his plan emphasizes a traditional pro-growth, conservative agenda. But make no mistake, Treasury Secretaries don’t create their own agenda, they execute the president’s agenda. To the extent that Trump’s priorities drift more toward disrupting the global free-trade system, Wall Street is likely to become less enthusiastic.

At present, the market is priced for perfection: high future growth and low volatility. But we’re about to begin the presidency of a man who views his mandate as, among other things, breaking the free trade, globalist world order that has been erected over the past few decades (starting with NAFTA in 1992 and culminating with China’s entry to the World Trade Organization in 2001). That sounds like anything but a low-volatility environment. There could be plenty of fireworks along the way. Specific Trump 2.0 policies to watch

To consider the implications of the specific Trump 2.0 proposals, we need to understand the main components of economic growth. Growth is created by changes in the levels of 1) population, 2) productivity, and 3) debt.

If we’re not careful, this three-legged stool can quickly lead us into thorny political waters. For example, the problem almost all Western countries have been wrestling with over the past decade is how to sustain economic growth (which their debt-laden economies require) in the face of sub-replacement level birth rates? From a purely economic growth standpoint, the answer is obvious — allow more immigration. This is why virtually all European countries, along with Canada and the U.S., are currently wrestling with the non-economic byproducts of allowing such rapid inflows.

President-elect Trump faces a challenging task — he wants to enact significant changes, but the current balance of economic growth and inflation is delicate. Growth and inflation tend to trend together, meaning that policies that boost growth often boost inflation as well. The opposite is also true: Policies that reduce inflation often come at the cost of lower growth rates. As such, the scope and sequencing of these policies will be critical. Some short-term pain is acceptable in pursuit of long-term gain, but too much is politically risky.

• Immigration. We may as well tackle the most contentious one first. There are many angles to this issue, some of which may outweigh the economic. But from a strictly economic point of view, it’s estimated that illegal immigrants comprise about 5% of the U.S. workforce. It’s generally accepted that illegal immigration depresses the wages of lower-income workers while, obviously, also making those jobs harder to obtain.Reducing immigration normally increases wage inflation, although that is likely to be a longer-term issue rather than a 2025 issue (assuming changes regarding immigrants already working in the U.S. will be implemented gradually rather than abruptly). Rapid mass deportations, on the other hand, would seemingly set the stage for labor disruption/shortages in certain industries (hospitality, food, and construction) while also being a significant blow to the economy, as losing 5% of the workforce would cause a substantial drop in spending on goods and services.
• Tariffs. This is the other huge wild card. Trump has proposed higher tariffs than the U.S. has seen in the past 100 years. It’s impossible to know how the rest of the world would respond, but economic history is clear: retaliation is likely. This is why many believe Trump won’t actually do it.But beyond Trump’s rhetoric that “tariff” is his favorite word and President McKinley (known as the “Napoleon of Protection”) his favorite president, Trump has also discussed trying to pivot the source of government revenue away from income taxes and back to tariffs. Under current budget rules, Trump will need to find new revenue to offset his tax-cutting goals. It appears ongoing tariff revenue is part of this equation.While the longer-term effects of substantial tariffs may be positive for U.S. workers and manufacturing, the immediate impact is likely to be less rosy — higher prices on many goods. Tariffs tend to be “stagflationary.” They can lead to higher inflation (costs rise) with lower growth (less overall goods and services being purchased). Higher prices on things people have to buy means less money to spend elsewhere, reducing overall economic activity and growth.In theory, this pain would eventually lead to more U.S. manufacturing, more and better jobs, and so on. But it’s possible stagflationary pain (lower growth, higher inflation) comes first, while the benefits take a while to materialize. New manufacturing typically requires plants, equipment, infrastructure, job training, and so on, all of which take time to put into place.
• Deficit Reduction. While this wasn’t a focus during the campaign, the elevation of Elon Musk within Trump’s administration and the appointment of deficit-hawk Scott Bessent as Treasury Secretary have vaulted this to the top of the post-election conversation.This is a double-edged sword. From a long-term, structural standpoint, cutting the deficit is necessary. But it potentially comes at a short-term cost, as government spending employs people and boosts the economy in the short-term. This is the debt leg of the economic growth three-legged stool discussed earlier. Cutting debt (i.e., the deficit) hurts economic growth in the short term. It will be a strong temptation for Trump to follow the Biden administration’s example of forestalling recession by letting the spending spigots run wide open.It’s worth pointing out that over the past 70 years, the only U.S. recession that started when the budget deficit was even half as large as today’s 7.2% of GDP happened in 1990. That was when Iraq invaded Kuwait and the subsequent embargo nearly tripled the price of oil from $15/barrel in July to $42/barrel by October. Today’s obscene level of government spending suggests there is quite a bit of room to cut before being at risk of triggering a near-term recession.
• Deregulation. The economic argument for deregulation is clear in that it boosts productivity. Naysayers argue it comes with hidden costs (environmental, social, etc.), but we’re focusing on the economics here. This is always a favorite talking point of conservatives, but is often elusive to turn into actual tangible progress. That said, there’s plenty of seemingly low-hanging fruit to boost economic growth here.
• Energy Production. This is a prominent target of the deregulation focus, as there is a perception that the outgoing administration’s policies kept a lid on U.S. energy production. There were certainly examples of that, although it’s worth noting that U.S. energy production has grown significantly in recent years and we’re producing more than ever.How much more meat is left on that bone is an open question, but this is a vital part of the Trump 2.0 inflation calculation. Energy prices are a key input into consumer prices, so a win here would help offset potentially inflationary pressures we’ve discussed elsewhere.If energy prices increase rather than decrease (for whatever reason, domestic or foreign), inflation pressures will likely be a theme of the next four years. That seems unlikely in 2025 though (barring an Iran war or similar), as OPEC+ has been delaying adding surplus oil capacity back to the market all year in an effort to avoid tanking the price. Lower oil prices seem like the path of least resistance in 2025, which would be a boon to Trump’s economic plan.
• Taxes. Extending the first set of Trump tax cuts, which are currently scheduled to expire at the end of 2025, has been a huge Trump priority and looks likely given Republican control of Congress. While those cuts were initially stimulative (people had more money to spend than they did before), extending the current status quo likely won’t provide a big boost. It’s obviously better economically than the alternative of letting them expire, which would be a negative for spending and the economy. But this extension may not deliver the improvement to the economy that many seem to expect.On the other hand, other Trump 2.0 proposals do have the potential to boost economic activity by increasing the spending capacity of workers, retirees, and companies. These include ideas such as exempting tip income from Federal taxes, ending the taxation of Social Security benefits, and cutting corporate taxes for companies making products in the U.S.

Impact on U.S. Dollar valuation

The idea that the value of the dollar is constantly fluctuating relative to other currencies is something most Americans rarely consider. The full implications of dollar policy is an article unto itself, but we can’t consider significant changes to the global trade system without at least a cursory discussion of dollar valuation. Dollar valuation fluctuations have also played a significant role in the major market moves of the past few years, which is another reason trying to understand it is worth our effort here.

A key point is there is no “value of the dollar” in and of itself. There is only the value of the dollar in relation to one or more other currencies. The most commonly used measure of the dollar’s value is the U.S. Dollar Index (DXY), which measures fluctuations in dollar value relative to a basket of global currencies that is heavily weighted to the Euro and the Japanese Yen. When the dollar is gaining in value relative to other currencies, the U.S. Dollar Index (DXY) goes up and the dollar is said to be strengthening. Likewise, when the dollar index is falling, it means the dollar is losing value relative to other currencies and is said to be weakening.

In trade terms, exporters generally want their own currency to be weak, as it allows foreign buyers to purchase more goods using their own (relatively) stronger currency. This is why Trump regularly complains about the currencies of exporting countries like China being too weak — it gives those countries an advantage in global trade. Given Trump 2.0’s vision of bringing manufacturing back to the U.S. and turning us into a global exporter again, he would prefer a weaker dollar.

The problem is that many of the policies we’ve discussed promote a stronger dollar, not a weaker one. Tariffs promote a stronger dollar, as does reducing the deficit. Many of what SMI readers would consider “good” economic policies — specifically those that require the U.S. to borrow less — promote a stronger dollar.

Nor is a strong dollar a bad thing on balance, as it increases the purchasing power of U.S. citizens (great for foreign travelers, buying imports, etc.). As Treasury Secretary Robert Rubin succinctly stated in 1995, “A strong dollar is in our national interest.” It’s just that a strong dollar poses a challenge for manufacturing and exports, thus adding a headwind to this specific Trump goal.

The impact of Trump policies on the value of the dollar is important to investors for a number of reasons. For our purposes, it’s important to note that a rapidly rising (strengthening) dollar has been a key cause/contributor to financial market turmoil in recent years. Examples include:

• In 2020-2021, the dollar went down and stocks rallied;
• From January 2022 - September 2022, the dollar rose and stocks went down sharply;
• From October 2022 - July 2023, the dollar weakened and stocks rose sharply.

The correlation is not always this strong (e.g., the dollar strengthened during the fourth quarter of 2024 without an accompanying stock market decline). But the relationship between the dollar getting too strong and stocks correcting has been clear, even if the exact levels that trigger these market responses fluctuate.

The exact mechanics driving this are debatable, but the recent effects have been clear. When the dollar has gotten too strong, dysfunction in the U.S. Treasury market has been the result. These tend to be mini “crisis” type events that initially cause the prices of assets like stocks and gold to fall sharply. The Fed and/or Treasury respond to the turmoil in the Treasury market, which to this point has always meant pumping more liquidity into the system. This results in a rebound in asset prices.

It’s not at all difficult to envision the type of strong dollar sequence of events described here happening again, if for no other reason than it has happened multiple times already since COVID, even absent tariffs, deficit reduction, or other Trump 2.0 policy shifts that seem to skew higher the likelihood of a stronger dollar. This type of event is easy to envision as the trigger for the type of 8-15% market correction mentioned earlier without causing a recession that would push the market into a more severe bear market.

Putting the pieces together The main thing I hope to convey by walking through each of these policies is that there are way too many moving pieces involved to confidently predict the ultimate cumulative impact on the economy. Trump has said that he regrets deferring as much as he did to his staff and other D.C. “experts” during his first term. Expect a more aggressive Disruptor in Chief this time around.

If we give Trump the benefit of the doubt and assume his policies will cause the U.S. economy to boom as capital pours in from around the globe and U.S. businesses and workers thrive, that’s a tough vision to square with annual inflation of only +2.3%, which is what the bond market currently projects over the next 10 years. The labor market has been softening in recent months and falling energy prices could well help lower inflation in 2025. But the longer-term inflationary trend SMI has discussed could once again lead to higher prices in the second half of the decade.

There’s a long tradition of new presidents implementing their painful policies as quickly as possible upon taking office, so the positive benefits are obvious by the time their term is ending. Trump’s policy mix seems tailor-made for that plan, given its “pain now for benefit later” tilt.

But despite the market’s seemingly lofty valuations and bubbly investor sentiment, the risk of a near-term recession still seems low for the reasons articulated earlier. As such, there’s no reason to abandon our current investment positions out of fear of what might happen. Our portfolios will self-adjust as the economic impact of Trump’s policies becomes more clear.

Ultimately, these policies are unlikely to represent sudden, overnight changes. More likely, we’re at the beginning of a possible multi-year adjustment to the existing global economic order. If so, just as it was formed gradually over multiple decades, reforms will likely take place over an extended period as well. Those types of multi-year, gradual changes are best monitored and responded to by the robust, unemotional trend-following strategies utilized by SMI.