On January 20, Donald J. Trump became 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 back to the economic promisedland. As with all things related to “the Donald”, the question is: What is real—and what is bluster? Trump supporters (and the markets) are resting their hopes on three pillars—tax reform, deregulation and fiscal stimulus.
First is a corporate tax cut. 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 2 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 third 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 have responded 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 boost to contractors and materials and machinery suppliers of all sorts.
There’s an old saying that “personnel is policy” in Washington, DC. Many of the individuals Mr. Trump has nominated for key Cabinet positions appear to be the philosophical opposites of their predecessors. Where President Obama had a strict regulator, Trump will have an experienced business person. Wilbur Ross, for example, scheduled to head the Commerce Department, is known for his aggressive negotiating style in resurrecting moribund steel firms. Ross has already called out a litany of unfair Chinese trade practices, including illegal subsidies, intellectual property theft, currency manipulation and forced technology transfers. Ross (and others) appear to be ready to go to bat for U.S. entrepreneurs and small business people. This fact, combined with a generally friendly Congress, would indicate that the tax and regulatory changes outlined above have decent odds of being enacted. If they are, then there’s also a good chance that real Gross Domestic Product (GDP) growth can escape the 2 percent doldrums of the past 8 years.
Markets are not waiting, however. Trump’s victory on November 8 pushed U.S. stocks to new all-time highs early in 2017. Financial stocks, smaller firms and those exposed to better economic growth (cyclicals) have led the charge. The mushy post-financial crisis path of economic growth in the U.S. appears set to improve, perhaps markedly, and this could create entirely new stock market dynamics. Cyclical, small-cap and overlooked names in the industrial and financial segments of the market actually took off ahead of the election, as if the market knew what was coming. Investor focus appears to be shifting from multinational names that benefit from globalization to smaller firms that sell mostly domestically. Companies levered to higher interest rates have jumped since Election Day as well.
As always, the proof of the pudding will be in the eating. Donald Trump shocked the world, but maybe no one should have been surprised. Brexit and populist movements across Europe have been signaling for months that citizens of developed nations are fed up with the empty promises of globalization. The benefits of trade were never adequately explained, while the costs were glaringly obvious to the residents of the rust-belt states that put Trump over the top on November 8th. The newly elected President certainly talks a good game, but can he play a good game—and deliver on his promises? Markets obviously think so. Investors are beginning to bake in faster growth arising from expected across-the board tax cuts, reduced regulation and increased domestic spending on infrastructure, all policies within reach as a result of unified Republican government. The first six months of the new Trump Administration will likely tell much of the tale, and we will be watching with interest.