As Donald Trump prepares for a potential second term in the White House, the stock market has once again become a central focus. While the S&P 500 Index has enjoyed a remarkable surge since the start of 2023, investors are grappling with the potential impact of Trump's economic policy proposals, which many strategists believe could increase inflation and slow growth. The challenge for investors is to navigate this delicate balance, where Trump's desire to maintain a thriving market may clash with his policy agenda.

Riding the Trump Rollercoaster: Investors Brace for Volatility Ahead

The Trump Effect: Scorecard or Scourge?

During his first term, Trump frequently touted the stock market's performance as a measure of his success, taking credit for equities rallies and even considering firing Federal Reserve Chairman Jerome Powell for a perceived selloff. This close association between the market's fortunes and his own political standing has led many to believe that Trump will be reluctant to implement policies that could jeopardize the current bull market.

Eric Sterner, chief investment officer at Apollon Wealth Management, notes that "Trump considers the stock market performance as an important part of his scorecard." This sentiment was echoed by the market's reaction to Trump's 2016 victory, with the S&P 500 Index posting its best post-Election Day session ever and a surge of $56 billion flowing into US equity funds in the following week.

However, the current conditions are vastly different from 2017, with the S&P 500 already enjoying a remarkable two-year run, leaping 53% since the end of 2022 and setting over 50 records in 2024 alone. Additionally, interest rates are significantly higher, and the Federal Reserve may be less inclined to provide the same level of support as it did during Trump's first term.

Treading Carefully: Trump's Policy Proposals and Their Market Impact

Trump's campaign promises, which include hefty tariffs, mass deportations of undocumented workers, tax cuts targeted at corporations and wealthy Americans, and a protectionist approach to manufacturing, have raised concerns among investors. These policies, if implemented, could strain relations with key trade partners, increase the national debt, and potentially slow economic growth.

Strategists at UBS estimate that a 10% to 20% tariff on imports from all countries could lead to a 10% pullback in US equities and a mid-single digit decline in S&P 500 profits. Barclays' analysts project that the universal tariff combined with a proposed 60% or higher levy on goods from China would shave 3.2% off S&P 500 companies' earnings in 2025.

However, investors are banking on Trump's sensitivity to the stock market, with Wall Street leaders like JPMorgan Chase & Co. CEO Jamie Dimon expressing confidence that the president-elect will want to avoid triggering a market selloff with his tariffs. This belief has led some investors to preemptively sell shares of companies expected to suffer from the proposed levies, such as firms in the Nasdaq Golden Dragon China Index and consumer giants like Coca-Cola and PepsiCo.

Balancing Act: Trump's Dilemma and Investors' Conundrum

The key question for investors is how much the market will tolerate in terms of Trump's policy proposals. While the president-elect's sensitivity to the stock market's performance may temper his approach, there is a risk that he could become too reactive to daily market moves, potentially leading to further volatility.

Marko Papic, chief geopolitical strategist at BCA Research, notes that "Trump 2.0 will curb immigration and be forced to curb fiscal policy, the twin pillars of American outperformance relative to the rest of the world." This could limit Trump's ability to stimulate the economy and the stock market as he did in his first term, when he passed a $1.3 trillion spending bill and a $1.5 trillion tax cut.

Ed Yardeni, president and chief investment strategist at Yardeni Research, warns that if bond yields rise substantially due to fears of inflation and larger deficits, the stock market's optimism may be misplaced. "If bond yields go up substantially here on fears of inflation and larger deficits, obviously the stock market's getting it wrong," he said.

Ultimately, investors must navigate a delicate balance, where Trump's desire to maintain a thriving market may clash with his policy agenda. The market's reaction to Trump's win in 2016 may not be a reliable guide, as the current conditions are vastly different. Investors must remain vigilant and prepared for potential volatility as they navigate the Trump tightrope.