A New Administration: Five Investor Takeaways

The reaction of many in corporate America to the inauguration of President Trump to a second term has been positive, particularly with respect to the emphasis on his “America First” policy agenda and the prospect of lower corporate taxes and regulation. In addition to the positive commentary that has come from some significant corporate leaders, small business sentiment has soared. The National Federation of Independent Business — a small business advocacy organization — reports that its Small Business Optimism Index has reached the highest levels since 2018. In addition to deregulation, the prospect of higher growth and better business conditions/pro-business policies has improved sentiment among this group, which was particularly hard hit by surging U.S. inflation and interest rates.

Some of that optimism has translated into better performance for small capitalization U.S. stocks: The Russell 2000 Index has gained nearly 4% year-to-date, which is in line with the S&P 500 Index and comes after a lengthy period of meaningful underperformance. While the policy and sentiment catalysts are helpful, small-cap stocks should benefit disproportionately from a decline in interest rates, particularly at the shorter end of the yield curve. Many of these businesses finance their operations using short-term loans and floating-rate debt, and the steady grind higher in rates over the past several years has been a significant headwind. The 100-basis-point cut to the fed funds rate in 2024 should be helpful, though the updated forecast from the Federal Reserve, the evolving market viewpoint to fewer cuts in 2025 and a “higher for longer” policy will likely continue to put pressure on smaller companies.   

The incoming administration is focused on maintaining U.S. prominence in artificial intelligence (AI) as both an important strategic advantage and an essential pillar of national security. President Trump signed an executive order on Thursday that requires a deep-dive review of all existing policies and procedures that he believes have been overly burdensome and threaten to constrain America’s leadership in this important area. He also established a working group of White House technology experts and appointed a new Special Advisor for AI and Crypto. Trump has tapped venture capitalist and PayPal executive David Sacks for this role.

Additional news on the AI front this week centered around the importance of developing the required infrastructure. President Trump and leaders from SoftBank, Oracle and OpenAI (the developer of ChatGPT) announced the creation of a new initiative called “The Stargate Project” that intends to invest $500 billion over the next four years building AI infrastructure in the U.S., with the initial $100 billion aimed at quickly building a data center in Texas. Data centers are integral to the development of AI. This significant planned investment has generated even more excitement around AI, with a basket of AI-related stocks gaining nearly 6% since the inauguration.  

President Trump made a virtual appearance at the World Economic Forum in Davos on Thursday. While many of his comments were noteworthy, there was one in particular that is attracting attention: He called for an “immediate” drop in interest rates as part of his plan to stimulate the economy. His request to Saudi Arabia to lower the price of oil would, in theory, ease inflation and lead to lower rates. In his first term, the president was openly critical of Fed Chair Powell, noting in 2018 that the Fed was “way off base in what they are doing.” He was pushing back on the Fed’s interest rate increases at that time. While he professed some remorse during his first term for appointing Powell as Fed Chairman in February of 2018, he vowed after the 2024 election to keep him in place, recognizing that Powell would most likely refuse to leave if he were asked to do so. Fed Chair Powell has reiterated that he would not leave office early under pressure from the president, reminding us that removing him or any of the other Fed governors before the end of their terms is “not permitted under the law.” 

It is fair to project that we will likely see the growing tension between Trump and Powell play out more publicly over the next several months. At the same time, the data has been inconsistent with respect to inflation. While the December inflation reports showed more progress toward the 2% goal, and as we see additional signs of inflation abating — particularly in the housing market — it will likely take several months of improvement to convince the Fed to act. With the economy continuing on solid footing, they are in no hurry. Expectations for Fed rate cuts have fallen for 2025, with the market now expecting only two cuts in the second half of this year, which is consistent with our own forecast. 

The president has hit the ground running, signing several executive orders on inauguration day. He seems to be drawing on some important lessons from his first term: He has clear policy goals and has surrounded himself with a group of appointees and advisors that are energized to achieve them. The political process can be messy, however, and oftentimes what we hear initially about a particular policy proposal does not translate into actual policy.

Investors should expect a noisy few months as the president’s term gets underway, with frequent iterations and reiterations of proposals. Many of these have created market volatility and will likely create more volatility in certain geographies and sectors. The challenge for investors will be to maintain their focus on the long term and stick with their strategic plans amid the temptation to trade around the daily news coming out of Washington. We expect this volatility will not only manifest in equity markets but also in interest rates, as the new Treasury Secretary Bessent formulates his specific strategy and the administration spars with Fed Chair Jerome Powell about the level of the federal funds rate.