The search term “Trump’s first 100 days” generates more than 31 million results, highlighting the symbolic importance of the 100-day milestone. Despite considerable media attention, investors remain uncertain about the prospects for the stock market under President Donald Trump.
Some aspects of Trump’s economic platform would promote growth and a healthy stock market, while other aspects would be likely to have a more detrimental impact.
“Mr. Market” is an imaginary investor created by Benjamin Graham, widely known as the “father of value investing.” Graham’s Mr. Market was a clever device used to demonstrate foundational concepts of investing. A hypothetical letter from Mr. Market to the president would provide a window into the market consequences associated with key economic policies under consideration by the Trump administration, such as tax policy, entitlements, regulatory reform, trade and health care.
[See: 9 Most-Loved Stocks in the Trump White House.]
Here’s how such a letter from Mr. Market may appear today:
Dear President Trump,
More than half of Americans own stocks, either directly or indirectly through mutual funds and exchange-traded funds. Consequently, stock market returns are important to both Main Street and Wall Street. Equities rallied strongly after the election, helped in part by hopes that the Trump administration would implement market-friendly economic policies. Although the market rally has continued into 2017, sentiment is fragile given uncertainty associated with the direction of economic policy and mounting concern that legislative gridlock will prevent meaningful action on taxes, entitlements, regulation and health care.
Tax reform. The U.S. has the highest statutory corporate tax rate in the developed world, though many companies benefit from deductions that dramatically reduce their tax rate. Successful small companies often are unable to take advantage of deductions commonly used by large companies, and consequently are more likely to pay the maximum statutory tax rate. Small company stocks rallied strongly after the election based on optimism that corporate tax reform would be an early priority.
U.S. corporations owe taxes for income earned outside the U.S., but the taxes are deferred until the earnings are repatriated to the U.S. Apple has more than $250 billion in cash, about 90 percent of which is “trapped” overseas because of the tax burden associated with repatriation.
Corporate tax reform that includes lower statutory rates, fewer deductions and a territorial approach to taxation would boost small-cap stocks and reduce disincentives that keep multinational companies from bringing their cash back to the U.S. The potential boost to economic growth and revenue from a reduced repatriation tax would offset much of the budget impact of corporate tax reform.
The U.S. reportedly has as many tax preparers per 1,000 people as Indonesia has doctors, highlighting the unnecessary complexity of the tax code. Reform of the personal tax code is far more challenging than corporate taxes given the greater impact on the federal budget and vested interests associated with deductions potentially on the chopping block.
The incremental growth associated with the tax outline presented by the Trump administration is likely to offset only a fraction of the loss in revenue. With U.S. debt more than 75 percent of gross domestic product today and projected to rise materially in coming years, a multi-trillion dollar tax cut would be likely to create inflationary pressure and an unsustainable budget deficit. Tax cuts and simplification are desirable objectives, but a scaled-back plan is necessary.
Entitlements are a problem. The aging of the baby boomers will create significant budget challenges, absent tangible steps to address Medicare, Medicaid and Social Security obligations. Mandatory outlays, including debt servicing costs, are projected by the Congressional Budget Office to be nearly 100 percent of federal revenue by 2030. Given the magnitude of “mandatory” spending on entitlements, cuts to discretionary spending won’t be nearly enough to stabilize the budget.
Without progress on Medicare, Medicaid and Social Security, the U.S. may fall into the demographic, deficit and debt trap faced by Japan today. The stock market would embrace a “down payment” on entitlement reform.
Investors want regulatory reform. The regulatory pendulum swings from one extreme to another. Scandals or financial crises often occur during periods in which regulation is lax; then the pendulum swings in the opposite direction after a scandal or crisis. The Sarbanes-Oxley Act, or anti-fraud law, was passed in response to financial reporting and governance abuses at Enron, WorldCom and Tyco; the Dodd-Frank Act was a response to the systemic risks exposed during the global financial crisis. When the pendulum swings to a tighter regulatory environment, there are often unintended economic consequences. Small public companies today struggle with costs associated with complying with a tighter regulatory regime, while some successful private companies cite regulation as a major reason to stay private.
Part of the post-election rally was attributable to optimism that the regulatory approach under the Trump administration would be more growth-friendly. Equity investors would welcome a regulatory structure that addresses issues with “too big to fail” banks and shortcomings in capital market structure, but imposes less of a straitjacket on banks and insurers that don’t pose systemic risk. Equity investors want “better” regulation and would be dismayed by efforts to dismantle the entire regulatory safety net.
[See: 11 Ways to Buy Bank Stocks.]
Unfair trade practices exist. Trade is a more nuanced issue than is acknowledged by pro and anti-trade advocates. The expansion of global trade has provided benefits to shareholders of multinational companies and given consumers a wider selection of goods and lower prices for many goods. However, unfair trade practices still exist throughout the world, and there are logical reasons to want to update trade pacts such as NAFTA. Trade and immigration are often blamed for the loss of American manufacturing jobs since 2000; however, the losses have much more to do with productivity gains than with unfair trade or immigrants. Despite the loss of manufacturing jobs, manufacturing output has increased. Robots have “stolen” far more jobs than Chinese or Mexican workers.
Tariffs may provide political benefits, but an escalation of trade tensions would hinder economic growth. A trade war, particularly with China, would be disastrous for equities.
Health care faces reform again. The Affordable Care Act has serious flaws, but the replacement initially proposed by the Trump administration also has significant shortcomings in economic and political terms. The Affordable Care Act’s individual mandate was intended to bring younger, healthier people into insurance markets, subsidizing older individuals and the coverage of pre-existing conditions.
The individual mandate is highly unpopular and relatively easy to manipulate. Adverse selection is a perpetual challenge for insurance companies, and forced coverage of pre-existing conditions made this problem worse. Absent limitations on enrollment timing and pre-existing conditions, many individuals have the incentive to remain uninsured until they have an illness or a need for insurance to cover an expected change in health. With enrollment in insurance exchanges below expectations and expenses higher than expected, insurers are dropping out of insurance exchanges or imposing steep premium increases.
Replacing the Affordable Care Act with legislation that causes millions of people to lose insurance coverage or which imposes steep cost increases will be unpopular and economically harmful.
[See: 7 of the Best Health Care Stocks to Buy for 2017.]
Former Wall Street Journal editor George Melloan recently wrote, “Markets are a force of nature.”
Governmental policies contributing to sustainable economic growth may boost the stock market, but the market also punishes ill-conceived and anti-growth economic policies. Government attempts to control or manipulate markets usually backfire, causing more harm than good. In a world of slowing growth, debt and demographic challenges, government policies have a significant influence on economic growth. The right choices can boost economic growth and the stock market. The wrong choices can have the opposite effect.
Sincerely, Mr. Market
Disclosures: Investments in securities are not insured, protected or guaranteed and may result in loss of income and/or principal. This communication may include opinions and forward-looking statements. All statements other than statements of historical fact are opinions and/or forward-looking statements (including words such as believe, estimate, anticipate, may, will, should and expect). Although TFC Financial Management believes that the beliefs and expectations reflected in such forward-looking statements are reasonable, it can give no assurance that such beliefs and expectations will prove to be correct. Unless stated otherwise, any mention of specific securities or investments is for hypothetical and illustrative purposes only. Adviser’s clients may or may not hold the securities discussed in their portfolios. Adviser makes no representations that any of the securities discussed have been or will be profitable. Nothing in this communication is intended to be or should be construed as individualized investment advice. All content is of a general nature and solely for educational, informational and illustrative purposes.
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Dear President Trump: A Letter From ‘Mr. Market’ originally appeared on usnews.com
