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The ongoing stock market bubble that has been inflated by a strong rally in AI stocks could pop prematurely if former President Donald Trump wins the 2024 election.
That's according to Capital Economics chief markets economist John Higgins, who said in a note on Thursday that Trump's proposed policies regarding tariffs and immigration would spell disaster for the economy.
A second Trump Presidency "could potentially result in the imposition of universal tariffs and reductions in immigration," Higgins said. "Universal tariffs and less immigration would cause growth to be slower and inflation to be higher than otherwise."
Such a scenario would be a nightmare for the Federal Reserve, as higher inflation via potential tariffs would limit their ability to cut interest rates, even if economic growth slows.
"Despite the threats to growth from such trade and immigration policies, the Fed might be less inclined, if at all, to loosen policy in such circumstances. This is because the policies would jeopardise its victory against inflation. That, in turn, could undermine equity valuations, because higher expected interest rates would drive up Treasury yields all else equal," Higgins said.
Capital Economics has held the view that the stock market will continue to hit records to as high as 7,000 by the end of 2025 before the bubble pops, similar to what happened in the 2000 dot-com bubble.
"It's worth recalling that the dotcom bubble burst in the wake of tighter Fed policy and higher Treasury yields," Higgins said.
What's more, if Trump wins a second term as President and Republicans gain control of Congress, the potential for a surge in fiscal spending would also put a cap on the Fed's decision to cut interest rates.
"The public finances are in a more parlous state than in 2016. So, conservative lawmakers in the party would presumably oppose a wider budget deficit, for fear of falling foul of the bond vigilantes. And even if they didn't, a big fiscal expansion would give the Fed even more cause to reassess the appropriate stance of monetary policy given the threat that it would pose to price stability," Higgins said.
And in the event that Trump doesn't win the 2024 election, Higgins said the stock market bubble will still be at risk of a potential slowdown in corporate earnings, lagging Fed policy finally hitting economic growth, or something "out of left field to rock the boat, perhaps geopolitical in nature."
Despite the risk of Trump prematurely popping the stock market bubble if he wins the 2024 election, Higgins is standing by his call for now that the S&P 500 will soar to 7,000 through 2025 before it ultimately crashes back down.
