Making Sense: Election Edition | Market and Policy Insights

Amy: Hi, I'm Amy Thomas, a strategist here at First Citizens Bank. We're stepping away from our usual market update to bring you information about the recent election outcome.

On Wednesday, November 13, 2024, our Chief Investment Officer Brent Ciliano, and Director of Market and Economic Research Phil Neuhart sat down with Wealth Planning Director Nerre Shuriah to talk about some of the potential policies and broad market implications for the next 4 years and beyond.

As always, the information you're about to hear are the views and opinions of only the authors at the time of recording and should be considered for educational purposes only. None of the information you're about to hear should be considered as tax, legal or investment advice.

Phil: Thank you for joining us today. It's been roughly a week since the election result. And with time to reflect, we wanted to sit down and have a discussion on a few topics.

One, what's the impact to our clients? Two, what's the impact to the broader economy? What do we see in terms of foreign policy, particularly tariffs? And then finally, what is the underlying market reaction? Obviously, markets have moved on this.

Brent, before we get started, you've had a lot of conversations with clients of late—in times in which headlines are really driving all of our emotions, et cetera. What are you saying to clients in terms of how to focus from an investment perspective?

Brent: Yeah. We've been privileged to have a lot of conversations over the last week or so with clients. And I think the first thing from my perspective is that we have to be incredibly open minded to the diverse set of views that our clients have because elections are very, very personal, and people take them very, very seriously. I think broadly from a portfolio and investing perspective, I think it's, "What should I be doing in my portfolio differently post the election results?"

And I think the thing that we've been talking to clients most about is trying to separate fundamentals of what goes on in the markets from policy and potentially rhetoric as it relates to what was said on the campaign trail. We think that's important to focus on fundamentals when you build portfolios.

The good news is that our process doesn't need to rely on elections or any exogenous or endogenous event. We are perpetually dynamic in the way that we build portfolios. Every single quarter we're developing our forward-looking capital market assumptions for the next 3 years and optimizing portfolios to make sure that clients always have the right exposures in the portfolio based on our opinion. What to own, when and how much is critical to the way that we build portfolios. So we've had a lot of broad conversations to get clients to focus away from that policy and rhetoric and more on fundamentals, Phil.

Phil: So, Nerre, a popular topic coming out of this election—every election, of course—is taxes, but in this election it's particularly the extension of the 2017 tax cuts. What are your thoughts there? What's the likelihood of that extension, and what other impacts might individual income tax and just taxpayers see coming out of this election?

Nerre: So this election tax policy was really at the heart of a lot of the conversation. It's not always at the heart of every election. In particular, we're looking at the Tax Cuts and Jobs Act.

A lot of people were concerned about whether or not the repeal would happen, which was set to sunset at the end of 2025. And I think with the reelection of President Trump, I think a lot of our clients are feeling now that, "Oh, I can relax. I don't have to do any planning. It's probably just going to, you know, come back again and everything that is in place will stay in place."

And I would say that, it's one to watch because the economic situation at the first 1.0 Tax Cuts and Jobs Act is not the same as 2.0. Another thing to take into consideration is that even though the Republicans won most of Congress, you need 60 seats in order to pass any legislation easily—regardless of its content. But if you have less than, you have to pass it under a process called reconciliation.

And with reconciliation, it has to be budgetary-focused, and it's subject to a lot of limitations. And that's what caused the sunset for Tax Cuts and Jobs Act in the first place. So if that's what the process that they'll go under this time, I think a lot of more the fiscal conservatives will see this as a chance for a do-over and look at some of the provisions where they can maybe reduce some of the cost because we have, you know, record deficit right now is at $1.8 trillion.

The cost of extending Tax Cuts and Jobs Act is projected to be $4.6 trillion over the next 10 years. So this is an opportunity for some of those members to say, "Hey, where can we cut some things so that it doesn't affect our economy quite so much?"

Phil: And some of the specifics, some things that I know are on our clients' minds—what about the top-income tax bracket? What do you think happens on that front?

Nerre: So Tax Cuts and Jobs Act did reduce that to 37%. It was previously 39.6%. I would say that's probably going to stay the same. The thing that I think most of our clients in that bracket were concerned about was the wealth tax. And that was something that the Democrats were proposing, and that's likely not going to happen.

Phil: Yeah. That was a hot topic during the election.

Nerre: They can rest on that front.

Phil: What about the estate-tax exemption? That's another hot topic for wealthy individuals. What are your thoughts there, and what should clients be doing and thinking about with some uncertainty around that exemption?

Nerre: So Tax Cuts and Jobs Act doubled the exemption. The exemption is set at $5 million. It doubled it to $10 million. But that exemption is also indexed for inflation.

So right now, it will be $13.990 million for 2025. That's quite a high number. And I think we were trying to get some of our clients to take some action with gifting or getting their estate planning in place when we thought that gifting ability might go away. But I would say that even—whether it stays or doesn't go away—it's important to get in front of your planning.

Planning doesn't involve taxes as the highest priority. Most people are doing planning because they need to, you know, care for their loved ones. They have family values. They want to distribute their assets. And at a certain level, the chance of your estate being audited is quite high—almost, you know, certainly. So it's important to do your estate planning, whether this tax stays or not.

The other is, as I mentioned a minute ago, it's not likely that—and remember, I'm not a prognosticator—but it's not likely that the Tax Cuts and Jobs Act will be a 2.0 wholesale, right? There's going to be some give and take. So if there's some things that will expand, other things will contract, and maybe one of the things that might contract would be the size of that estate-tax exemption as a possibility.

Phil: So that's individuals from a tax policy perspective. What about business owners? What impact might you see there?

Nerre: So I hate to keep harping on the Tax Cuts and Jobs Act, but since that is likely to come back around again, that did have some provisions benefitting business owners. Those things will likely stay in place. But there were some promises or campaign issues that I think business owners need to pay attention to.

One of them is tips. So it was proposed that tips would no longer be taxed. If that's the case, how that would occur is something I think business owners need to pay attention to. They may need to recharacterize some employees, and that may or may not help employees. I think some owners may decide to lower base pay for employees thinking "Hey, you're going to get a bit of an advantage with, you know, since tips are tax-free."

The other is overtime pay. Overtime pay changed last year. The threshold for employees who should receive overtime pay—which is 1.5 times their pay for any hours worked over 40 hours—increased from employees who make around $38,000 to $58,000 a year. That was a big jump. And it came in two tranches. The second tranche should hit January 1st. That was something that was put in place by the Department of Labor but basically through the Biden administration.

If this administration doesn't want that in place, they can—through their new people in the Department of Labor—change it. But it's actually a populist type of measure, right? So if they change that, that really hurts the working person, the working man. And I don't know how popular that would be.

So again, that's something that business owners need to change their payrolls to fit, but they need to really pay attention to.

Phil: So Brent, turning to some of those fundamentals you discussed, what might the election mean for the broader economy—if it means anything? What are your thoughts there?

Brent: Yeah, well I think, Phil, the good news is that, you know, the economy in the United States is already thoughtfully on solid footing, so that's a great starting point.

So when we think about that and you think about US growth overall, not only has growth been remarkably strong over the last 3 years—we saw revisions in September—2022 moved up from 1.9% to 2.5%, 2023 moved up from 2.4% all the way up to 2.9%. And for 2024, we started at 1.3%, and we've now doubled that and we're up to 2.6%. So broadly, growth is really strong in the United States.

From a labor market perspective, we still year to date are creating almost 200,000 jobs. And certainly we've moderated lower from the highs that we saw back in 2021. But job creation in the United States still remains robust, but moderating more back to our normal point. And most importantly, from a consumer-spending perspective, consumer spending on services remains remarkably robust, sitting at 7% year over year, which is more than 2/3 of all spending. So by and large, Phil, the US economy is firing on all cylinders, so that's critically important as we start.

Phil: As long as the consumer have jobs, they tend to spend.

Brent: That's right. That's right.

Phil: It's an American tradition, and we are seeing that, whether you look at retail sales data or personal consumption data. We're still seeing a consumer that's spending, which is roughly 70% of GDP.

In terms of some of the stuff Nerre talked about from a from a tax perspective, could that impact consumer spending? How are you thinking about that?

Brent: Absolutely. I mean, look, the Tax Cuts and Jobs Act—I think we have to be very, very thoughtful here—is that, that in and of itself is not overall stimulative. In essence, it would be to prevent fiscal contraction. So I think this stuff, as Nerre said, isn't sunsetting until the end of 2025. So at the end of the day, I think this would hopefully be continued to be pro-growth and pro-business if we continue to extend.

Phil: That's right. It's not an expansion. It just avoids contraction.

Brent: Exactly.

Phil: Another thing that's really on our clients' minds coming from one administration to another is the regulatory component, right? There is a lot of optimism now that personnel is policy, right—that old saying. And I've heard my colleague Blake Taylor use that. The idea that appointees to certain government agencies really can drive some policy from a regulatory perspective. So there is optimism right now.

I think it's one of the reasons we've seen small cap outperform large cap. That M&A, mergers and acquisitions could pick up, and maybe that opens up the IPO window. But these—we're in the realm of the unknown right now.

Brent: That's right.

Phil: But that is the hope. When we talk to clients, we are hearing they hope that there is a less of a regulatory burden and that could encourage some M&A activity—which, of course, just drives capital flow, which is a real positive.

Brent: Well, and I think we also have to remember that while many of the companies within the S&P 500 are US domiciled, they're subjected to global regulation, global policy, global antitrust.

So just because you have a potentially more thoughtful regulatory and antitrust environment in the United States doesn't mean that US companies are going to be immune from that. But certainly, to the point, especially for mergers and acquisitions and IPO activity, lower antitrust is going to be a big deal for, let's say, the tech sector or healthcare or sectors like that.

Phil: Certainly driving optimism, but that's a long road before we really have the answers there. What about on the immigration front? What do you think in terms of impact there? Obviously, we've had a lot of immigration into the country. There is a belief that that may have actually boosted some growth just because there's more consumption that way. What are your thoughts from immigration perspective and potential impact?

Brent: Yeah. I think that's certainly, in our opinion, a bigger wild card, right? And certainly there's balance there. Things that were said on the campaign trail and things that could affect various sectors—whether that's healthcare, industrials and specifically the technologies sector, and broader healthcare in aggregate—relies very, very heavily on immigration and workers from abroad.

So I think we're going to have to really get a deeper understanding as to what the new government might do as it relates to broader immigration. If it were to be overall restrictive, it could be difficult because we are already at a point where jobs are still hard to come by and there's still a lot of open spots specifically in a lot of those sectors. So that would actually worsen the situation, not make it better. So time will tell.

Phil: The job market has normalized, but we still have one job opening for every unemployed person. So it's still fairly tight. So certainly immigration can help companies that are short of labor.

In that same vein, well, what about the hot topic, the buzzword—tariffs, right? Certainly, a lot of campaign promises. What comes through is a real question mark, but certainly, there's confidence that it'll be a tough-on-China approach. As a market person—not a policy analyst—as a market person, how do you think about tariffs and a potential impact there?

Brent: Yeah, and I think it really matters on the level as far as, you know, what country or countries are exposed to tariffs. I think on the campaign trail, there was a lot said. So 60% tariffs on China, 20% on the rest of the world. What will actually be enacted, what will ultimately stick, certainly would impact supply chains, would certainly impact prices. It would have an impact potentially on corporate profitability. Margins could be affected. Supply chains could potentially be disrupted.

So we don't think that that's the case. I certainly don't think that's our base case. We do see that there is certainly bipartisan support, as you said, Phil, for tough-on-China. But by and large, we're just going to have to wait and see how deep and how far and how many countries are exposed to tariffs.

Phil: Yeah. There's some amount of pass-through from tariffs, right?

Brent: Yeah, has to be.

Phil: We know the consumer pays for some of that, and company margins pay for some of it. So that money comes from somewhere. It restricts capital flow in some way. There has to be an impact. A question we often hear from clients is, "What about monetary policy related to things like tariffs and other trade policies and other economic policies?"

We did see the number of Fed cuts expected come down following the election, and it was falling ahead of the election. In other words, not cutting as much as previously expected. Some of that is because some of these policies could be somewhat inflationary. But just a reminder for everyone, the Fed is going to be focused on their dual mandate. So these policies are going to affect Fed policy to the extent that they affect either full employment—in other words, the labor market—or inflation.

That's really the question. So if these policies were not to drive changes in the rate of inflation or changes in the labor market, they may not impact monetary policy. But to the extent they do, the Fed's going to have to address that. And this Fed has shown, after being very late to hiking, that they are committed to keeping inflation low or at least in that 2% to 3% range.

Brent: Yeah. And Phil, I don't think it's going to take much. We also have to remember that while inflation is absolutely moderating lower, right, we're still seeing areas of very sticky inflation, right, specifically on the services side. We just talked about services spending by consumers annualizing at more than 7% year over year, right?

So it's not going to take that much if we were to see an underlying impulse from tariffs across the board raising prices being passed through the consumer to where we would have to get into an environment, like you said, where the Fed might have to slow the pace of rate cuts. And again, is this going to be ultimately a midcycle adjustment, or are we going to see something different? Only time will tell.

Phil: Right. And speaking of rates, we have seen markets react to this election in a number of ways. One, interest rates across the yield curve have risen leading into the election and after. What's interesting is we saw a big move in—if you watch the 10-year Treasury, for example, the day after the election—and then a big move down and now a big move up. So a lot of it is volatility, but on trend, higher rates. Why is that? If you believe the Fed is cutting less, that has to find its way into the yield curve, into interest rates. Some of that is not about the election. A reminder that the market—unlike us—the market is not only watching the election.

Brent: Back to fundamentals.

Phil: We had some surprisingly good employment data that was released early October. Rates rose on the back of that. The number of Fed cuts expected fell on the back of that. So some of this is just good old-fashioned fundamentals that the economy has been more resilient than many have expected for quite some time now. What else have we seen? Risk assets have rallied.

Brent: That's right.

Phil: Particularly if you look at US stocks, small caps have rallied. Well, why is that? More domestically focused. Potential for, if there is an economic reacceleration, they benefit. And not to mention, they've just lagged so far in the last couple years, so there's more of a catch up there. You've also seen other risk assets like crypto rally.

Brent: Yeah.

Phil: There's very policy-specific regulatory reasons for that as well. What do you think in terms of dollar strength, Brent? We have seen that rise. Obviously, rates have something to do with that. What is that about in terms of dollar strength that we've seen lately?

Brent: Yeah, and certainly we saw that in the 2016 cycle, right? 2016 through 2020 we certainly had dollar strength. And certainly it's likely to follow, US foreign and trade policy will have a big impact on the dollar.

And not that you want to get technical into a concept like interest rate parity where, you know, inflation differentials, currency differentials and inflation differentials across the board all kind of move in tandem, right? So if we have higher rates, potentially stickier inflation—that usually bodes well—or bodes for a stronger US dollar relatively across the board.

And to kind of take it back to your risk asset conversation, we've already started to see that affect risk asset prices within international stocks. Both developed and emerging have sold off a bit in anticipation of a stronger dollar policy as a byproduct of what was talked about in the campaign trail as it relates to trade and foreign policy in aggregate.

Phil: On net, from our perspective, we remain constructive. Our price target on the S&P 500 is 6,200. We just raised that recently. When we raised it, I believe it was up 6.5% to 7%.

The market has moved towards us, but we do remain constructive. That does not mean we won't have volatility, right? When you have a new administration and we're trying to figure out policies, which this discussion really highlights, there's still a lot of uncertainty—that can drive uncertainty in the marketplace.

So it's not that we continue to march higher in a straight line. We do have elevated valuations in a lot of risk assets, but we do remain constructive from a US equity market perspective.

Brent: And to bring this back to where we started the conversation, Phil, about what clients are asking as it relates to portfolio construction. Tying into what Nerre said, have a financial plan. Have your goals and objectives. When you invest in your portfolios, make sure you understand why you're investing to begin with, and make sure that your goals and objectives are aligned to your investment policy statement and how you allocate your assets.

Tactically timing or speculating getting into the market, out of the market rarely ever works out, and we should stick to that thoughtful financial plan and specifically a thoughtful portfolio construction approach.

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Authors

Brent Ciliano CFA | SVP, Chief Investment Officer

Capital Management Group | First Citizens Bank

8510 Colonnade Center Drive | Raleigh, NC 27615

Brent.Ciliano@FirstCitizens.com | 919-716-2650

Phillip Neuhart | SVP, Director of Market & Economic Research

Capital Management Group | First Citizens Bank

8510 Colonnade Center Drive | Raleigh, NC 27615

Phillip.Neuhart@FirstCitizens.com | 919-716-2403

Nerre Shuriah, JD, LLM, CM&AA | SVP, Senior Director of Wealth Planning

First Citizens Bank

8510 Colonnade Center Drive | Raleigh, NC 27615

Nerre.Shuriah@FirstCitizens.com | 919-716-7646

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