The market’s message isn’t always correct, but it’s a good place to start. Over 4 sessions after Election Day, the S&P 500 rose by close to 4%. However, by the close last Friday, that gain had moderated to closer to 3%. Another way to look at the market post-election is to note no change after the first two days. The euphoric combination of promises of lower taxes and less regulation was worth a boost. But after the instinctive move upward, closer inspection of what’s to come showed both some plusses and minuses.
One of the “fears” that erupted was that inflation was going to reaccelerate as tariffs were imposed and mass deportations began. But that message conflicts with the bond market’s behavior. Even after the Fed cut rates by 25 basis points on November 7 and a subsequent CPI report showed less progress in the fight against inflation than expected, the 10-year Treasury yield was virtually unchanged from Election night and from a year earlier.
As we all know, markets’ instant reactions are often not all that accurate. While controversy has swirled as Trump identified his Cabinet choices, only four could be described as controversial and one, Matt Gaetz, has already been withdrawn and replaced. The other three, Robert Kennedy, Jr., Tulsi Gabbard, and Pete Hegseth, while tangentially important to some parts of the economy, are not choices that should have a dramatic impact on Wall Street. The one exception is Mr. Kennedy whose choice buffeted many stocks of companies within the healthcare sector, particularly those close to the process of developing new biotech drugs. All the other nominees appear headed for approval with the caveat that the vetting processes have been swift and further vetting by Congress may reveal some speedbumps.
The choices seem to have in common loyalty to Trump and a willingness to shake the tree in order to streamline processes and improve efficiency. Trump isn’t the first incoming President to try and improve government efficiency. Almost every President has taken some stab at doing so. Perhaps the most recent high-profile example was Obama’s Simpson-Bowles commission, a cross party effort that couldn’t even get enough support from within to present its findings to Congress.
There are reasons to believe that this time might be different. Trump isn’t looking for bipartisanship, at least at the start. He has set up a DOGE group of outsiders, led by Elon Musk and Vivek Ramaswamy, to shake the trees really hard. While non-defense government spending accounts for only an eighth of total government spending, it is fertile ground. By some estimates, the total number of Federal regulations exceed 1 million. Very few have expiration dates or sunset provisions.
To make a point, look at the state of California. It’s population in 2024 of about 39 million is essentially unchanged from 2015. But the number of state employees over the same period rose from 231,000 to over 262,000, an increase of 13%. In fact, the entire net job growth within the state over that period was a result of the increase in state government employees. We know that California had a positive birth rate over the same period and has significant net migration as well. The obvious conclusion is that many Californians left the state.
California is notoriously one of the most, if not the most regulated state. One must look no further than the price of gasoline to see the economic impact. The average price for a gallon of regular gasoline today in California is $4.31 compared to the national average of $3.06. I am not arguing that all of California’s additional regulations are improper. But the reason I point the state out here, is that residents have the option to leave if the costs of the regulatory burden get too high. And that is exactly what is happening. The cost doesn’t just show up in gasoline. It shows up everywhere and that includes state income taxes. The regulatory burden is regressive as well hitting those who must spend 100% or more of their income the hardest.
Famously, when Musk bought Twitter, he immediately fired about half its employees. For lots of reasons, he will not be able to do that within the Federal government. But he can make a start. Every regulation has a cost. The regulatory burden alone for one to open a beauty salon is estimated at over $7,000. That’s the cost to the operator. In addition, the regulators have a supervisory cost, reviewing paperwork and forcing compliance. Musk can’t deal with the state and local regulatory burdens, but he can suggest ways to reduce Federal requirements, particularly when they overlap or conflict with local rules.
With all this said, reducing human infrastructure means reducing headcount. That will face resistance. In some cases, the DOGE group will overstep and be forced to retreat. But no one can argue that out of $6.5 trillion of government spending saving just 3% will reduce deficits by close to $200 billion per year or $2 trillion over a decade.
While those who feel that government oversight is a good thing will push back, I suspect that if done right and in a compassionate way, the vast majority of Americans would favor a broad effort to ease the regulatory burden.
Simplistically, some have observed that lower immigration numbers and the impact of tariffs will be inflationary and raise the Federal deficit. On a standalone basis, that might be correct. But if Federal expenses can be reduced sufficiently to offset those impacts, the result would likely be greater growth and only a moderate impact on inflation.
Let’s circle back to the 10-year bond yield. It is now 4.4%, the same as before Election Day, and virtually identical to a year ago. Simplistically, the 10-year yield can be viewed as the sum of the economy’s expected rate of growth and the long-term rate of inflation. Ideally, one would hope for higher growth in a more efficient economy with moderating inflation expectations. Growing too fast, without commensurate growth in capacity, would lead to higher costs. Inflation is the market’s mechanism to balance supply and demand. During Covid, inflation was flamed by excessive government spending that lasted too long. But the biggest factor creating higher costs was the breakdown in supply chains. Less supply meant it had to be rationed. Higher prices resulted as part of the rationing process.
Today, supply chains are largely healed. Looking forward, we don’t know what tariffs lie ahead. We don’t know the pace of workforce reduction tied to efforts to limit immigration and deport undesirables. Nor do we know the benefits of regulatory reduction. Not only do we not know the size of each, we also don’t know the timing.
Disruption can be a good thing if done properly and humanely. There are few reasons to expect that all disruptions will go smoothly. But what matters is the net result. If you ever read a brokerage research report, you will note several pages of footnotes mandated by lawyers, mostly a result of regulatory requirements. When I started my career as an analyst, the hedge clause was a paragraph of modest size. No one reads those footnotes. When you must accept on a consent form, online, do you read what you are consenting to? That’s the relatively harmless impact of over regulation. But for the small business owner, the thousands needed to be spent up front just to open the door, on top of the capital costs necessary to commence operations, may be the difference between a bright new business and one that never gets started. If peeling back the regulatory burden is done properly, costs to do business will decline, creating a powerful deflationary force.
The stagnant bond yield suggests the jury is still out. We will learn a lot over the next six months. The Musk/Ramaswamy DOGE effort will end on July 4, 2026 as America celebrates its first 250 years. One can only hope it’s a successful project. To me success would be simply bending the curve, eliminating dead wood and regulations that are no longer necessary in anyone’s book. Pushback by unions, those advocating greener initiatives, etc. are inevitable. Courts will have their say. It will be interesting to watch, a battle worth having.
Today, Christina Applegate is 53.
James M. Meyer, CFA 610-260-2220