There are three big ideas to consider in the wake of Donald Trump’s stunning election victory.
The first is that we have a business man in the Whitehouse, so America’s business will be business not government. The most probable positive outcome of the election is a change in corporate tax rates, given Trump’s emphasis and the broad support within the Republican Party. American businesses have the third highest marginal federal tax rate in the world at 38.92%.1 Consequently, U.S. corporate after tax profitability is hindered on the international stage where most of their competitors can be more profitable and competitive simply because they pay lower taxes.
If the US Federal corporate tax rate declines from 35% to 15%, a company earning $100 million in pretax income would net, after taxes, $85 million versus $65 million, a 30.7%2 jump in earnings, by the stroke of a pen! With a stock market that has been overvalued by most valuation metrics, except the Fed Model which measures the stock market value relative to historically low rates, this new tax code would be a game changer. If earning improve, interest rates can rise without risking a market decline. This will benefit retired people who can again earn decent return on the money in their bank accounts and money markets. Safe money will not be drawn into risky investment and capital will be allocated more responsibly. This will reduce bubble risk, a serious concern.
There are other secondary effects. Lower tax rates could lead to solid US growth e.g. factories could return to the US as the tax reduction offsets the lower labor costs in other countries. This would help spur U.S. job growth and tax receipts. This would lessen the need for government to reallocate capital from wage earners and tax payers to government subsidy beneficiaries. Fewer transfer payments would reduce government expenditures. Of course, this tax rate driven growth will come at the expense of foreign countries’ growth. Optimists, conservatives and supply siders would argue that the incremental increase in business will offset the marginal decrease in tax revenues. Lower taxes could drive US growth back to the dynamic 4% levels not seen in years.
The second big idea is that the Trump election marks the end of decades of excessive monetary intervention and a shift toward fiscal policy for economic stimulus. Since the 2008-9 financial crisis, central banks around the globe have been pushing interest rates to historic lows as illustrated by $13 trillion3 of foreign sovereign bonds with negative interest rates. Yet, despite these extraordinarily low rates, global economic growth has barely escaped stall speed. Some market observers are concluding that lower interest rates not only have lost their increment effectiveness but negative interests rates are detrimental to growth, eroding bank profitability and constraining their risk appetite to lend.
Consequently, in addition to simulative tax policy, a Trump administration which promises massive infrastructure spending could accelerate economic growth, if these programs are administered effectively. Further, a refurbished military would also create economic stimulus which has been conspicuously absent in recent years. If the Trump administration’s economic plan proves as dynamic as the Regan administration’s, interest rates on the 10-year Treasury note could rise to 6%. In 2000, the 10-year Treasury note yielded 6% and a return to those levels should not be disruptive to equity markets. While higher rates might hurt stock market valuations, higher bond rates would allow pensions to invest safely in risk free US Government bonds to meet their actuarial targets and improve capital allocation. This would reduce bubble risk. Jeff Gundlach, one of the most insightful market observers and revered bond managers, also sees a 6% 10-year Treasury note in the next 4-5 years.4
The third big idea that the Trump victory suggests is a repudiation of a push toward globalism. Some have argued that establishment or “elite” politicians subscribe to the view of a singular global economy, where unchecked immigrations is good and traditional working class families must compete against low cost labor from countries like China, Malaysia, and Vietnam. The stunning Trump victory was foreshadowed by the stunning Brexit win, when the silent majority of economically penalized middle class workers voted out the establishment government that embraced a global view of open borders and unrestrained free trade.
Trump’s win has been defined as a populist response to globalization. Trump opponents have cast the president elect as a xenophobic…. As political analysts say, people vote their economic experience. The last 16 years of US economic growth have left retired and middle class America financially weakened while the wealthy have enjoyed improved financial circumstances from asset appreciation spawned from lower interest rates and expanding corporate profit margins.
Looking ahead, as an economic conservative (e.g. low taxes and small government), I expect that the Trump presidency could generate solid economic growth if it is properly implemented and politically feasible—which the current congressional majorities suggest. However, economic theory and economic reality can prove unrelated. I expect that the US equity markets will hold up and appreciate while economic growth and interest rates will rise. The timing of policy implementation and the relationship between the bond market and the equity market, will undoubtedly provide periods of volatility which should be used as buying opportunities. Again and again, history has shown being a contrarian investor is rewarding over time.
Best wishes to you and your families this holiday Season.
Tyson Halsey, CFA