January 3, 2017
So far, the market response to the Trump victory has been quite bullish. In 2017, three key questions regarding Trump’s proposals face investors: 1) How will they be translated for legislative approval? 2) How quickly will they be implemented? and 3) What types of businesses are likely to benefit from their enactment?
THE THREE PHASES OF UNEXPECTED CHANGE
Often, when major unexpected economic, political or other events emerge, the market impact occurs in three phases: Initial Reaction, Speculation and Emerging Reality (Exhibit A). We’ve had two major unexpected events this year with the Brexit vote in June and Trump’s win in November. In light of the unprecedented nature of this past election cycle, these three phases may be even more pronounced as investors digest what a Donald Trump White House will mean for their portfolios over the short- and long-term time horizons.
PHASE ONE: TRUMP’S UNEXPECTED WIN
In the first phase, which typically marks the first few trading sessions following an unexpected event, the markets essentially provide what amounts to a “hot take” on what the change will mean for the broader economy and business growth. It is common for markets to oscillate considerably over a short time frame. In the case of Trump’s unexpected win, the Dow initially reacted negatively to the increased uncertainty, dropping 800 points in election night futures trading. However, the day after the election, the Dow closed up 257 points. Trump’s pro-business agenda advocated on the campaign trail combined with Republican control of the Senate and House propelled domestic equities higher absent any new facts—other than selection of one of the two presidential candidates known to everyone the day before. Expectations for a stronger dollar, meanwhile, served to steepen the yield curve initially.
PHASE TWO: TWO MONTHS PRIOR TO INAUGURATION
The market’s rapid response of apparent stability in Phase One helped set the backdrop for the second phase. This second phase has been marked by the early actions of the President-Elect and initial reactions to his cabinet nominees and other material facts (e.g., November’s New York Times interview, etc.). In the month that followed the election, for instance, Trump’s selections for key posts served to inform market participants of a more pragmatic, “pro-business” policy approach than anticipated (although there has certainly been some broader controversy surrounding some of the cabinet nominees). As the markets transitioned from the first to the second phase, the focus of most investors—independent of social, environmental and international issues—has been on six key areas: taxes, banking, energy, healthcare, infrastructure, and trade. At this early stage, the markets have interpreted (rightly or wrongly) President Trump to be more tempered than Candidate Trump, at least as it relates to these key policy positions.
Key Policy Positions and Proposed Cabinet Members
Taxes and Bank Regulation: Steve Mnuchin, Treasury Secretary nominee, has stressed that lowering taxes and easing the regulatory burdens on banks are two of his biggest priorities. However, he is not necessarily calling for the outright repeal of Dodd-Frank, but rather wants to eliminate the complexity that serves to impede small business loans. Regarding corporate taxes, he’s advocated for the repatriation tax plan advocated by Trump and has also articulated lowering the top business tax rate from 35% to 15 percent. Tax reform is central to Mnuchin’s mandate to stimulate growth and get the GDP to a sustained 3% to 4% range.
Energy and the Environment: Other policy initiatives may have a more direct impact on specific sectors. Within energy, for instance, Trump’s selection of Ryan Zinke for Interior Secretary fulfills a Trump campaign pledge to increase U.S.’ energy independence and may be favorable for the coal industry (Zinke has supported coal development on Federal lands). Scott Pruitt, nominated for EPA Administrator, is considered to be a climate change skeptic and has been a vocal proponent of fracking. Rex Tillerson, Trump’s nominee for Secretary of State, also brings energy sector expertise as the former CEO of ExxonMobil. Independent of long-term environmental issues, these selections directionally indicate a favorable short-term pro-energy position which the market has imbedded in stock valuations.
Healthcare: This is another complex area that has been in the spotlight. President-elect Trump’s nomination of Tom Price as the Health and Human Services secretary would seem to confirm that the new administration intends to see through its campaign promises to roll back the Affordable Care Act. As a Congressman, Price introduced legislation aimed at replacing Obamacare, a proposal that sought to stall Medicaid expansion and eliminate the individual mandate (In fact, fully repealing the Act will be virtually impossible under a probable Senate filibuster and Republicans can’t agree on how to replace it).
Infrastructure: One of the biggest uncertainties that has dominated the second phase of the post-election market cycle relates to Trump’s promise of $1 trillion in infrastructure spending. This would provide a tailwind to the construction, manufacturing, and materials sectors, and naturally buttress employment. Approval may be complicated, though. The new administration has selected a number of deficit hawks for key roles who might challenge a proposal. For instance, Mick Mulvaney, nominated for the Office of Management and Budget Director, voted against raising the debt ceiling back in 2011.
Trade: With the proposed appointment of Wilbur Ross as Commerce Secretary, Trump is selecting an experienced investor and executive who is quite knowledgeable about international trade. However, considering that most of Mr. Ross’ business ventures have relied upon financial engineering, significant headcount reductions, and offshoring, it will be interesting to see how his approach fits with President-e lect Trump’s campaign rhetoric. Since being nominated, Ross has stressed that tariffs are merely part of trade negotiations with other countries, and typically the “last” line of defense against cheating or efforts to game the market. Given this uncertainty, many global conglomerates are waiting to gain more insights into the Trump administration’s approach to both trade and taxes.
How will all of these policy areas impact investment markets in 2017 and beyond? Answering that question during Phase Two requires a skillful blending of the current facts and some thoughtful projections. As we go to print, there are many evolving factors that challenge our formulating forward-looking expectations. Acknowledging that background, we have established a template (See Exhibit B) to outline our current opinions on how various industries may be impacted.
PHASE THREE: 2017 POST-INAUGURATION
After January 20th, the policy discussions will be translated into reality, reshaped, or, in some cases, abandoned. However, we expect that most of the directional Phase II actions will take some time. There will also be other questions that stem from the potential corollaries to the proposed agenda: Will the stimulus from “Trumponomics” translate into a strong dollar that inhibits economic growth? Will company funds that are repatriated back to the U.S. be deployed toward growth initiatives or merely channeled toward buybacks and dividends to support stock prices? How will these policies affect emerging market economies? And, to what extent are best-case scenarios being priced into the market, and what will be the reactions to policy disappointment or delay?
While there is significant talk from the incoming Trump administration claiming that widespread implementation changes will occur in the first 100 days of the presidency, a number of realities exist that will likely affect that perception. First, while Trump can make some changes without Congressional approval – such as those related to trade, the environment, and other regulations—he will need Senate approval for his Cabinet choices. In addition, he will need the entire Congress’ support for policy changes in healthcare, taxes, infrastructure, and other areas. In addition, depending upon when President Trump wants to address it, there will likely be significant Congressional debate over his nominee to the currently vacant seat on the Supreme Court. Further, although the Republicans have majorities in both houses of Congress, it is unknown how united they will be in proposing and passing legislation. Once legislation is approved, it will then take time for implementation to occur. We expect that it may take anywhere from six months to two years for some policies to produce the full impact of their intentions.
Our core investment beliefs around asset allocation, diversification, and a long-term perspective have guided Fiduciary Trust through all types of economic environments. While the next four years may be challenging, we expect this approach to provide the best guidance going forward. Our investment strategy, focused on optimizing risk-return tradeoffs, is designed to protect against the downside risk that often accompanies uncertainty. As we expect many of these questions and themes to play out throughout 2017, we will continue to evaluate the positioning of client portfolios within the context of a stable, long-term approach.
The opinions expressed in this article are as of the date issued and subject to change at any time. Nothing contained herein is intended to constitute investment, legal, tax or accounting advice, and clients should discuss any proposed arrangement or transaction with their investment, legal or tax advisers.