Markets reacted positively to Donald Trump's election victory, but David Kelly, the chief global strategist at J.P. Morgan Asset Management, isn't celebrating. While U.S. stocks surged—sending the S&P 500, Nasdaq, and Russell 2000 up by 2.5% to 5.8%—bonds took a hit as yields spiked in response.
This market response aligns with Kelly's expectations. With Republicans gaining control, Trump is in a strong position to push through substantial tax cuts in 2025, which would directly boost corporate after-tax earnings and drive the stock market higher. However, Kelly warns that these cuts could trigger inflation—a risk that weighed on Democrats in the recent election.
Kelly notes that while tax cuts are positive for corporate profits, they could also elevate inflation and increase the U.S. national debt, creating headwinds for bonds and potentially weighing on stocks over time.
The Potential Downside of Tariffs
Kelly's biggest concern lies in Trump’s proposed tariffs, which he believes could derail the economy and halt global growth. He likens tariffs to a "nuclear threat"—a last resort with severe consequences. Tariffs, essentially taxes on imports, typically lead to higher prices and slowed economic growth. Kelly asserts that if Trump implements these tariffs, he would need to raise his inflation target and lower his long-term growth outlook, as countertariffs would harm U.S. exporters and could slow growth while raising inflation.
"Retaliatory tariffs hurt growth in both countries and push up inflation in both countries," Kelly said, describing them as a "stagflation elixir." Tariffs are one of the few measures capable of sparking stagflation—a combination of sluggish growth and rising prices.
As a worst-case scenario, Kelly sees the possibility of a global trade war becoming more likely. Citing Mahatma Gandhi, he adds, "A tariff for a tariff will make the whole world poor."
On the campaign trail, Trump proposed aggressive tariffs, including a 60% tax on Chinese imports and a 20% tax on all other imports. When asked whether these measures might be effective, Kelly replied unequivocally: “No. I’m not being political; I just assumed it was consensus that free trade was beneficial.”
Kelly went on to challenge anyone to provide evidence that tariffs foster domestic economic or job growth, stating he's never seen a long-term study that supports this view.
Tariffs May Not Be Set in Stone
While Kelly’s stance on tariffs is firm, other strategists show less concern about Trump’s trade policy. Some even believe that the rhetoric might not match the reality.
One such voice, Tom Orlik from Bloomberg Economics, aligns with Kelly, warning that tariffs could have “seismic impacts” on the U.S. economy by stifling growth and spiking inflation. But others, like Chris Murphy, cohead of derivatives strategy at Susquehanna, suggest Trump might back away from tariffs if markets respond negatively.
Sean Gallagher, Lazard's head of small-cap equity, shares Kelly's reservations about tariffs but doubts they will play out as aggressively as Trump has proposed. Gallagher, a free-market advocate, is generally opposed to tariffs and believes most Americans share his stance.
Ultimately, Gallagher expects some level of tariffs but believes they will be less severe than Trump’s campaign rhetoric suggests. He points out that inflation, a critical issue that helped Trump win, will be an ongoing concern for his administration.
"Trump’s team will need to weigh the inflationary impact of tariffs," Gallagher said, adding that nobody wants to reignite inflation.
In conclusion, the market may be celebrating now, but significant risks lie ahead, particularly if Trump's tariff policies materialize as planned.
