The newly split government is not likely to produce any significant legislation, but it will probably fuel heightened volatility in the markets, according to Andrew Friedman, founder and principal of The Washington Update. Friedman was a key speaker at Investments & Wealth Institute’s recent Investment Advisor Forum.
Normally, the markets welcome a mixed government and a lack of significant new legislation in Washington because it means there is less likely to be surprises, Friedman said. But, this split government is apt to cause the markets to roil.
That volatility is likely to be fed by threats of the imposition of tariffs, Congressional hearings on Trump administration malfeasance, and brinksmanship over raising the debt ceiling.
Trump’s imposition of 10 percent tariffs on some Chinese goods, his wider imposition of tariffs on steel and aluminum, and his threat to impose 25 percent tariffs on all Chinese goods have already caused turmoil in markets, said Friedman. Further threats or trade-related action will produce more turbulence. Conversely, markets have responded favorably to announcements of possible trade accords.
Now that the Democrats have control of the House, they will be conducting hearings investigating three questions: Did Trump collude with the Russians; Did Trump obstruct justice by firing Former FBI Director James Comey and other actions; and what evidence is there that other crimes may have been committed?
The hearings will “bog down” the administration as it is obliged to gather documents and prepare testimony, Friedman said. Since the markets have shown that they “liked” the Trump presidency, by generally rising, the disruption of the administration will be met with market volatility, he said. Markets have responded favorably to the administration because of the tax cuts, the reduction of regulations, and the increase in corporate earnings.
The Congressional investigations could lead to impeachment, but in Friedman’s view, conviction by the Senate is unlikely “unless there is demonstrable, incontrovertible evidence of malfeasance.”
Friedman further noted that Rep. Maxine Waters, D-Calif., chairman of the House Financial Services Committee, has already called several CEOs of major financial institutions to testify. If the committee turns up wrongdoing on the part of such financial institutions, that could lead to regulatory actions that would further contribute to volatility, he said.
The recent budget agreement pushes the next decision about government funding to the fall, when Congress will also have to decide whether to raise the debt ceiling, Friedman said. While there is likely to be brinksmanship over these decisions, Friedman said he doesn’t expect another government shutdown.
“I don’t think the president or Congress will mess with the country’s credit rating,” Friedman said. “I don’t think even the president wants to upset world markets.”
One area in which there may be some agreement between the Democrat- controlled House and the Republican-controlled Senate is on the need for infrastructure spending. The fundamental difference between the two parties is how to pay for it – Democrats believe funds should come from the federal budget; Republicans believe they should come from the private sector. One possible compromise could be to obtain funds by increasing the gas tax, which hasn’t been raised in 26 years, Friedman said. If Congress does agree to allot funds for infrastructure spending, several sectors, including high tech (for broadband services), construction, and materials would benefit.
Friedman also provided tips on how clients can circumvent aspects of the new tax code that may be unfavorable for them.
Noting that state taxes were no longer deductible, Friedman said that, nevertheless, if clients used any part of their homes for business, they could claim deductions for the proportion of property and state taxes commensurate with the proportion of their homes used for business.
He also said that although interest on home equity lines of credit is in general no longer deductible, the interest on such loans used for home renovations remains deductible.
While charitable deductions may not seem worthwhile to some clients because the individual’s total deductions do not exceed the new, higher, standard deduction, clients over 70½ may want to make charitable contributions from their IRAs, he said. Individuals over 70½ can take up to $100,000 out of their IRAs and give it to charities, tax free.
If clients under 70½ bundle their charitable contributions in a single year to bring itemized deductions above the standard deduction, they too could receive a tax break. If such clients don’t want to deduct so much money in a single year, they can achieve the same benefit by setting up a donor-advised fund, which distributes funds gradually.
Friedman also noted that if clients arrange to give away their estates under the increased exemptions granted by the new law, and if those higher limits are reduced after the current law’s exemption expires in 2026, there would be no clawback. That is, the bequest would still be exempt up to the limit of the existing law, not a subsequent one.
While entertainment is no longer deductible under the 2017 law, meals given in combination with entertainment for which there are separate receipts are still deductible.
