Steering through the fog of policy uncertainty

I just got back from the ABA Wealth Management conference in sunny San Diego. There, Strategas’ Dan Clifton and I talked about President Trump’s actions, their market impacts and how we, as professional investment managers, would translate these developments into portfolio adjustments for the post-election landscape.

The opening days of the second Trump administration have, thus far, been marked by heightened uncertainty. Investors are concerned that inflation will reaccelerate, the Federal Reserve will remain on hold or even hike rates, tariffs and government layoffs will derail the economy, and tax cuts will be delayed or diluted. These concerns have also led to a decline in consumer and business confidence, a freeze in business investment and conservative earnings guidance.

While we acknowledge that the risk of a short-term economic soft patch has risen, we remain constructive on the economy and markets in 2025. Rather than share the market’s concerns, we view these fears as bricks in a healthy wall of worry. Here’s why:

Inflation

According to the recent Core PCE Data, the Fed’s preferred measure, inflation is currently running at 2.6%. While this is still above the Fed’s 2% target, it’s far tamer than the elevated levels seen a year or two ago. We expect inflation will continue to grind lower as season factors abate and we see easier year-over-year comparisons. Any economic soft patch that we may currently be experiencing is also likely to help ease inflation pressures, in our view.

The Fed

While the Fed continues to talk up inflation risks, we think the committee is spending too much time looking in the rear-view mirror. The recent increase in unemployment claims, falling confidence measures, and softer economic data suggest that, in the short run, the risks to growth outweigh the risks to inflation. Regardless of the committee’s rhetoric, we think economic data will force the Fed into cutting rates this year, with two cuts as our base case expectation.

DOGE 

About 25% of jobs added to the economy over the past two years were in government positions, up from 5% in 2021 and 7% in 2022. DOGE has been trimming many of these, but while the cuts will certainly impact the Washington, D.C., area, we do not expect they will derail the overall labor market. The total number of federal jobs stands at just over three million—less than 2% of the US labor force.

While the layoffs mount, we expect total job losses will be in the 100,000 to 200,000 range. As long as the private sector remains strong, the economy should have no problem absorbing those workers, especially considering that the private economy has faced a labor shortage over the last several years. Over the medium term, productivity should increase if these workers are reallocated from the less-efficient government sector to the more-efficient private sector.

Tariffs 

We expect that tariff uncertainty will peak over the next month. While Trump has certainly used tariff threats as a negotiating ploy, the fuller picture of his strategy is coming into focus. The administration is finalizing plans for a reciprocal program, in which the US would equalize tariffs on imports to match those levied by foreign countries on US goods and services. Ultimately, we expect that other countries will lower their levels to avoid facing higher US tariffs.

Remember, the US is the biggest buyer of the world’s goods, and the first lesson of business is that the customer is always right! That said, as the Trump administration views value-added taxes (VAT) and non-tariff barriers as essentially equivalent to tariffs, we may also see US tariffs increase to offset foreign VAT levels. This is far from a catastrophic outcome, and the removal of tariff uncertainty should help economic activity and confidence measures recover.

Taxes

Finally, we expect tax cuts will come into focus between now and Memorial Day. With Congress essentially agreeing to move forward with “One Big Beautiful Bill,” we anticipate the extension of the 2017 tax cuts, an increase in the State and Local tax deduction limit and the potential elimination of taxes on social security benefits, overtime and tips. On the business side, we are also likely to see immediate expensing reinstated and the potential for an even lower corporate tax rate for companies that produce products in the US. While the sausage-making process is likely to be messy, we think that these tax cuts will be a big net positive for the economy.

All together, we see a second half of the year marked by less uncertainty, lower inflation, rate cuts, lower taxes and a rebound in economic activity. In other words, a very solid environment for markets.

Fixed Income 

For investors willing to accept some volatility, we think it makes sense to take the first step out the yield curve. Despite Fed Chair Jerome Powell’s recent statements, we believe policymakers will cut rates over the next couple of years and that some of the best opportunities are in the 1-3 year part of the curve. Not only are yields attractive relative to stable-value investments, but rate cuts present the opportunity for price appreciation.

Equities 

European stocks have had a good start to the year, but it’s hard not to get excited about US equities. Despite market noise and the potential for a temporary soft patch, the US is anchored on solid long-term fundamentals: underlying economic growth remains solid; inflation, while sticky, is sub-3%; and corporate earnings grew 12.5% in the fourth quarter—the strongest pace in three years. This keeps us constructive on stocks.

We continue to see the equity market broadening out, so we like defensive dividend payers, as they generally have been less volatile during this period of heightened uncertainty. If volatility recedes later in the year, we think cyclicals will do well in anticipation of higher growth and increased business activity. We also believe that small and mid-cap companies will respond well to lower taxes, less regulation and lower interest rates. On the large-cap growth side, we remain neutral. We think the Mag 7 remain unparalleled cash-flow generators, but valuations remain elevated, particularly in light of questions about the monetization of AI.

So, as winter turns to spring, our view for a bifurcated year remains more-or-less the same, and we will stay the course. Markets are difficult to time, especially given the speed of policy changes by the new administration. We remain guided by the fundamentals that keep us bullish.