Cathie Wood warns that Trump's return to the White House could trigger a bubble in Tesla stock.

If former President Donald Trump were to win the 2024 election, the stock market bubble inflated by AI stocks could be prematurely burst.

John Higgins, chief market economist at Capital Economics, said last week that Trump’s tariffs and immigration policies would be disastrous for the economy.

Higgins said that Trump’s re-election would likely bring widespread tariffs and reduced immigration, leading to a slowdown in economic growth and higher inflation.

This would be a nightmare for the Fed, as higher inflation from potential tariffs would limit its ability to cut rates even if economic growth were to slow down.

In this scenario, the Fed would probably be less inclined (if at all) to ease policy even if Trump’s trade and immigration policies threaten growth, as these policies would undermine its fight against inflation.

This would in turn weaken stock valuations as higher expected interest rates would push up bond yields under other conditions.

Capital Economics expects the S&P 500 to continue to hit new highs before the bubble bursts, reaching 7,000 by the end of 2025, similar to the dot-com bubble in 2000.

Higgins notes that the dot-com bubble burst after the Fed tightened policy and bond yields rose.

More importantly, if Trump were to win the election, the possibility of increased fiscal spending would also cap the Fed’s room for rate cuts.

The US public finances are more precarious than in 2016, so the party’s conservative members of Congress would probably oppose expanding the budget deficit, fearing a backlash from bond vigilantes.

Higgins adds: “Even if not, a large increase in fiscal spending would also make the Fed more likely to reassess the appropriate stance of policy as it would threaten price stability.”

Higgins expects that the stock market bubble would still face a series of potential risks if Trump does not win the 2024 election, including a slowdown in corporate earnings or the Fed’s eventual impact on growth from lagging policy, or “something unexpected, possibly geopolitical.”

While Trump’s victory in the 2024 election could puncture the stock market bubble prematurely, Higgins still maintains his view that the S&P 500 will soar to 7,000 by 2025 before eventually falling.