Since the inauguration of Donald Trump on January 20th, markets have given the new President the benefit of the doubt that his business-friendly policy objectives will result in both faster economic growth for the U.S. and higher corporate profits. And thus far in 2017, corporate earnings reports have given investors confidence that profits can continue to make progress in the months ahead.
Many uncertainties remain, of course, about how the first year of the Trump Presidency will play out. To help investors frame their view of the markets and the economy, below are three potential positive developments for the financial markets as well as three potential risks. Given the administration’s wide-ranging agenda, there is probably a wider range of potential outcomes for the markets—both positive and negative—under Donald Trump than there would have been under Hillary Clinton.
Let’s take the positive aspects first (from an investor’s perspective):
First, perhaps the most potentially impactful policy objective of the new administration for investors is corporate tax reform. Right now the federal corporate tax rate in the U.S. is 35%, the highest in the industrialized world. If Congress were to reduce the corporate rate to, say, 25%, companies would receive an immediate and significant boost to their profits. Take, for example, a company that had pre-tax income of $100 and paid $35 in tax to result in a net profit of $65. If the tax rate were reduced to 25%, this same company would have profits of $75, 15% higher than under the 35% rate. If corporate tax reform is enacted, companies will likely have significantly more cash flow to pay dividends, invest in plant and people, make acquisitions and buy back stock.
Second, the administration is seeking to reduce regulations, particularly those in the financial sector. A loosening or repeal of the Dodd-Frank Act would give banks and other financial companies more flexibility in how to deploy their capital and would require them to hold smaller capital buffers. While such a reduction in regulations would likely be positive for loan growth and profits in the short run, it might also put our banking industry on thinner ice should there be another financial crisis akin to the one in 2008.
Third, during the campaign Mr. Trump talked a lot about rebuilding our infrastructure. While there is no firm plan yet in place to tackle this objective, increased fiscal spending on bridges, roads, airports and power infrastructure would probably be helpful not only for those companies involved in the actual construction but also for investor sentiment in general. The administration has floated the idea of using public-private partnerships for some projects, but we will just have to wait until a plan takes shape.
There are, naturally, also risks lurking that could derail economic progress in 2017. Here are three:
First, a geopolitical confrontation that ends badly (or persists) may have a chilling effect on investor sentiment. In the early weeks of the administration, U.S. rivals around the world are testing the President’s strength. Since Inauguration Day, North Korea has launched a missile into the Sea of Japan, Iran has tested a ballistic missile and Russia has deployed a new cruise missile that violates Cold War arms control treaties as well as had its combat aircraft conduct multiple aggressive fly-bys against a U.S. Navy destroyer operating in international waters in the Black Sea. It seems reasonable to expect that there could be a butting-of-heads with one of our rivals in the not-too-distant future.
Second, investors may develop increasing concerns over the finances of the U.S. government. The administration is proposing tax cuts for both corporations and individuals along with additional fiscal spending for defense and infrastructure. Doing all of this adds up to a larger budget deficit, which increases the rate at which the national debt (now $19.9 trillion) will grow. If global investors fear the U.S. does not have a good handle on its debt obligations, Treasury yields may rise, denting growth and potentially resetting both equity and bond markets lower.
Third, if the administration enacts protectionist trade measures, a trade war may ensue. The developed world is now very interconnected by trade and our own economy is heavily dependent on trade. Legislating on trade is also very tricky, as unforeseen and unintended consequences can often result. It is too early to predict how trade issues will develop, but it seems Mr. Trump is set on new frameworks for trade with both Mexico and China. A U.S. move toward protectionist policies will likely bring a response from our trading partners and may also cause investors to reassess our growth trajectory.
Though it is still very early in the new administration, the first few weeks have hinted that Mr. Trump may take a softer line on foreign policy and economic issues that what he espoused on the campaign trail—but who really knows? 2017 promises to be interesting. Stay tuned.
Please do not hesitate to contact me if there is anything about the markets or your portfolio that you would like to discuss.