The Trump agenda update: Does it still matter to investors?
President Trump and the Republicans in Congress have set out to achieve a very aggressive legislative agenda in their first 200 days. These policy initiatives pose an intricate web of positive and negative threads for global investors to grapple with. We’ve written extensively about how difficult it is to get things done in Washington DC. And the Trump Administration has not been immune to these challenges. Progress has been slow across a number of key policy dimensions—both for the better and worse for markets. Some of the scarier scenarios for global investors (like a U.S. trade war with China) look less scary; and some of the exciting scenarios for U.S. investors (like a “phenomenal” cut in corporate taxes) look less exciting. This reversion to the mean on policy, coupled with stronger international fundamentals, continues to support our view that non-U.S. stock markets can be great again under Trump. With that as a backdrop, let’s dig deeper into the current state of play on the policy agenda, with a focus on why each provision matters to markets.
Healthcare – We believe financial markets only care about healthcare reform to the extent that it informs upon the timing of tax cuts. The precise linkage between the two is quite complicated, but the basic idea is that, because Republicans only have a slim majority in the Senate, they are using a special process called budget reconciliation to pass key pieces of legislation with a simple majority, instead of the normally required 60 votes. The problem: Republicans are only allowed to do one reconciliation bill in each fiscal year and they have prioritized healthcare before taxes. Therefore, the longer the healthcare debate drags on, the longer investors must wait for tax cuts. While the U.S. House of Representatives passed its repeal and replace bill in early May, the U.S. Senate decided to start again from scratch.
Healthcare bottom line: Healthcare is way behind schedule and remains a major obstacle to the domestic economic agenda. Relative to expectations, our strategists believe these developments are negative for U.S. equities and positive for U.S. fixed income.
Tax reform – The prospect of a large cut in the corporate tax rate from 35% to 15% or 20% was arguably the primary catalyst for the post-election rally in U.S. equities. But, as noted above, the sluggish progress toward healthcare reform has also slowed down tax reform. For example, Treasury Secretary Steve Mnuchin recently described the Administration’s August timetable for tax reform as “highly aggressive to not realistic at this point.” We agree. But there’s another problem: How to enact a big tax cut in a revenue-neutral way—in a way that does not increase the national debt. This is a sticking point with fiscal conservatives. And it is a requirement for the tax cut to be made permanent under the special reconciliation process. House Speaker Paul Ryan’s Blueprint proposal achieved revenue neutrality by imposing a border tax. This proposal would tax U.S. companies for the cost of imported goods while exempting U.S. exports from taxation. Because the U.S. imports more than it exports, Ryan’s provision goes a long way to making tax cuts revenue-neutral, raising more than $1 trillion over ten years1. From an investments perspective, this was seen as a headwind to the emerging market economies that produce intermediate goods for U.S. businesses. But the border tax has since faded in popularity and looks very unlikely at this stage. At this point, there is no alternative to Paul Ryan’s plan and uncertainty on tax policy is high.
Tax-reform bottom line: Our best guess is that Republicans will eventually pivot from comprehensive tax reform towards a smaller, temporary tax cut in 2018 to check a box for voters in the run-up to the mid-term elections. Relative to expectations, our strategists believe this will be negative for U.S. equities and the U.S. dollar, and positive for EM assets and U.S. fixed income.
Infrastructure – This was one of the few economic policies that garnered bi-partisan support during the campaign. The problem mostly surrounds how to pay for a large infrastructure investment program. A well thought out plan could drive stronger economic growth in the U.S. over the long-run, but this will likely need to wait until 2018 or beyond when Republicans have finalized their work on healthcare and taxes.
Infrastructure bottom line: Our projection on the administration’s ability to pull off an infrastructure program is neutral—for now. But check back in 2018.
Small companies have regularly cited excessive regulation and red tape as being one of the largest problems facing their operations. The White House’s Office of Management and Budget (OMB) recently estimated that the cumulative cost of new regulations issued between 2006 and 2014 was between $69 and $103bn2. Of course, the financial crisis has taught us that smart regulation is incredibly important to the soundness and safety of the U.S. economy. But thus far, Republicans have already repealed fourteen3 Obama-era regulations under the Congressional Review Act. The regulatory review process is ongoing, but some progress has been made, representing a modest tailwind for markets.
Regulatory reform bottom line: We’ve seen some progress here, but it is very difficult to gauge the magnitude of the impact at this point.
The new administration’s potential trade policies were one of the biggest areas of worry in the market following Trump’s election victory. The list of worries was long: Trump could label China a currency manipulator, unilaterally withdraw the U.S. from NAFTA, impose tariffs on our trading partners and effectively start a trade war that could significantly endanger the global expansion in general and the emerging market economies in particular. So far, none of that has happened. While the U.S. did pull out of Trans-Pacific-Partnership (TPP) negotiations, President Trump has recently refocused his attention on ensuring free and fair trade for U.S. businesses. He has moderated his tone on China and opted to renegotiate NAFTA rather than withdrawing from it. We believe the ratcheting down of the anti-globalization positioning has been a favorable development for emerging market equities. The prospect of a trade war also ran the risk of stoking inflation, as retaliatory tariffs increase the cost of imported goods in the U.S.
Trade bottom line: As fears over trade policies have faded, we believe emerging market assets have benefitted and market-based inflation expectations have subsided, creating a supportive environment for U.S. Treasuries.
Overall bottom line: While there are several market-impactful policy proposals coming out of Washington D.C., we believe investors should continue to focus on fundamentals. This year, we believe investors have been rewarded for fading policy fears in Europe and fading policy excitement in the U.S. This is a trend we expect to continue. The U.S. economy is mediocre, but we believe the global cycle is strong. Valuations in non-U.S. markets are significantly cheaper. And we aren’t seeing enough progress on the pro-growth policy agenda in the States to warrant a change in view at this time.