On January 20, Donald J. Trump will become the 45th president of the United States, and we’re all wondering what “The World According to Trump” will look like. Given his penchant for late-night Twitter eruptions and policy head fakes, no one knows if the President-elect is serious about bringing fundamental change to the U.S. economy. The markets obviously think so, as U.S. stock prices have surged and bond prices steadily eroded since Election Day. Millions of people want to believe that President Trump will lead America out of the 2 percent growth “desert” and back to the economic promised land. But will he? Trump supporters (and the markets) are resting their hopes on three pillars – tax reform, deregulation and fiscal stimulus.
First is corporate tax cuts – The Trump administration is expected to reduce the corporate tax rate to 15 percent from 35 percent, and limit the top tax rate on pass-through businesses (such as partnerships) to no more than 15 percent. The President-elect is also proposing a tax “holiday” for the accumulated profits of foreign subsidiaries of U.S. companies held overseas. U.S. companies currently pay an effective tax rate of about 27 percent due to numerous deductions and exclusions, but even a 20 percent effective rate would boost aggregate S&P 500 earnings by approximately 10 percent. Interestingly, Wall Street strategists began upping their 2017 S&P 500 profit estimates soon after the election to reflect this change. As for the tax “holiday,” Mr. Trump has said he wants to repatriate about $2.6 trillion in overseas profits at a one-time tax rate of 10 percent, about a third of what is required by current law. These funds could then be used for increased U.S. investment, or be paid to shareholders in the form of dividends or share buybacks.
Next is deregulation – A key goal of some of the earliest potential Trump reforms. Various estimates put the cost of Federal regulation (in the form of lost output) at about $2 trillion per year. President Obama steadily increased the thickness of the Federal register during his tenure, with particular emphasis on health care, energy and financial services. President-elect Trump has said he plans to eliminate two existing regulations for every new one implemented. He’s expected to begin by repealing the Affordable Care Act, and reversing many rules put in place during Obama’s second term regarding wage and hour laws and environmental standards. Also look for changes (requiring Congressional approval) later in 2017 to several aspects of the Dodd-Frank Act, with particular emphasis on reversing the Volcker rule that limits bank trading activity. All in, Trump’s plan to lift the “animal spirits” within the economy by deregulating both small and large businesses appears to be already paying dividends. In addition to the rise in the stock market, various measures of consumer and small-business sentiment have reached levels unseen since before the 2008 financial crisis.
The final pillar in the Trump economic plan is $1 trillion in increased infrastructure spending – financed by project-specific tax credits granted over ten years. This initiative has received considerable criticism from Democrats because it doesn’t conform to classic models of deficit spending designed to maximize economic “stimulus,” whatever that is. Trump allies respond that Dems are upset because the plan focuses on moneymaking projects and reduces the amount of direct Congressional control relative to previous spending packages. Whatever its final form, a Trump infrastructure package is likely to provide a long-term fill-up to contractors and materials and machinery suppliers of all sorts.
There’s an old saying that “personnel is policy” in Washington, D.C. Many of the individuals Mr. Trump has nominated for key Cabinet positions appear to be the philosophical opposites of their predecessors. This fact, combined with a generally friendly Congress, would indicate that many of the changes outlined above have decent odds of being enacted. The next six months will tell us a lot.
One final note: Though their actions have been less prominent since Trump arrived on the scene, the Federal Reserve remains a key player on economic policy. With their latest interest rate increase, announced in December, the Fed continues to push toward a more “normal” interest rate regime. We can see this reflected in the greater variability of individual stock performance within the S&P 500 over the past six months or so. There has also been a much lower correlation between industry group returns. Put differently, stock picking is making a greater difference in portfolio performance recently, as the heavy hand of Fed policy is removed from the markets. We expect this trend to continue, leading to increased overall volatility, but a market which better differentiates the good from the bad. A less monolithic market in the future should play to our strength as stock pickers.