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Patience is a Virtue – No Matter Who is President

The results of the presidential election and subsequent communication from the administration have given investors plenty of cause for excitement. The possibility of lower taxes, deregulation of various industries, and a burst of infrastructure spending have all fueled expectations of higher corporate profits.  Indeed, the S&P 500 rose 10.6 percent from Election Day through February 21st, making all-time highs along the way, as investors flocked to equities.

Figure 1: S&P 500 Index since January 2016

February On Point

However, when expectations rise, it is important to keep a close eye on the substance behind them, so a cautious assessment of this policy agenda would be prudent. Notably, Wall Street economists and analysts have been reluctant to upgrade their high-level projections very meaningfully. A good measure of reflection accordingly shows that the ambition of this to-do list requires patience in making investment conclusions at this stage.  Furthermore, it is impossible to rule out surprises from this administration along the way, as the underlying theme of policy uncertainty stems directly from the President himself.  Here is a closer look at some of the most important issues concerning investors.

Healthcare Regulation

As the top Republican priority, the potential repeal and replacement of the Affordable Care Act might well occur in the foreseeable future, but the market has already anticipated changes still in their legislative infancy. The implications will be mixed, since nearly any meaningful change to healthcare policy will create winners and losers, but the existing status quo is subject to change as the new policy takes shape.  House Republicans have proposed a plan that largely favors health insurance companies, and stocks in these companies have duly outperformed the broader market.  However, the President has yet to endorse the plan or propose one of his own and has already extended the timeline for a completed one into next year.  Clearly reality will take time to catch up to expectations.

Financial Regulation

The second major vein of deregulation, rolling back the Dodd-Frank Wall Street Reform and Consumer Protection Act, could provide a short-term economic boost by easing lending restrictions, but these ambitions may be unrealistic. Major changes require 60 votes in the Senate, which has 52 Republicans.  Even if it does go through as hoped, lending conditions are already considerably accommodative, so there might not be much demand for more loans, and the banks themselves would see most of the benefits.  Finally, if the strategy does take effect as intended, the easier credit will work with a lag as it percolates through the economy.

Recent developments around this example really underscore the significance of policy uncertainty. While some deregulation of banks should be expected at some point, what and when are not quite clear.  So when the White House suddenly announced an executive order setting that process in motion, it caught the market slightly off-guard, and banks’ stock prices promptly rose, despite the fact that the order only commissioned a review without making any actual changes to the law.  This is a case-in-point that timing this sort of investment opportunity makes targeting it unsuitable as a short-term proposition.

Taxes

Of all the policy items under consideration, tax cuts arguably have the most potential to boost short-term growth, but their secondary priority level, legislative complexity, and the differences in opinions involved put the investment implications on shaky ground. While low taxes are a mainstay of GOP policy, Republicans including Trump have made clear that undoing the Affordable Care Act ranks higher as a legislative priority, which makes for a high hurdle before tax cuts can advance.  And while Congress insists that government spending cuts offset lower taxes, the Trump Administration has telegraphed that it is happy to widen the deficit.  So it could be months before there is any clear indication of future fiscal policy, and possibly a year or more before implementation, depending on the course of action taken.

Full-scale tax reform could deliver long-term benefits to the economy, but it would take considerable time to work out and come with plenty of uncertainty about potential winners and losers. As precedent, the Tax Reform Act of 1986 took over a year from start to finish, and that was when the tax code was considerably simpler.

A few, more expedient options exist, but each comes with a trade-off. The quickest options utilize a process called budget reconciliation, which lowers the bar of Senate votes required from 60 to 50, within Republican reach.  However, if the plan increased the deficit outside of 10 years ahead, it would then expire, as the Bush tax cuts did.  While Congress might be inclined to support such a plan, the Administration likely favors lowering taxes more than spending, which therefore increases the budget and boosts economic growth.

A further possibility would be to combine tax cuts with simplified reform and some infrastructure spending, appeasing Democrats to gain the votes necessary for a permanent, deficit-expanding package. This option would boost the economy in the short term and include some long-term investment and possibly efficiency.  However, the possible inclusion of border adjustment in this scenario introduces the risk of serious economic disruption, and of course compromise takes time.

Figure 2: Illustrative Examples of Possible Tax Plans

Infrastructure Investment

Despite the broad appeal of its practical results, infrastructure spending plans would have relatively minor implications for economic growth. As many homeowners know first-hand, construction takes time to plan and more time to implement.  Despite the enormity of the trillion-dollar figure being floated, the years necessary to complete works at that scale would dilute the added growth nearly to a rounding error against our $19 trillion-and-growing economy.

Furthermore, congressional Republicans do not care much for infrastructure spending, especially if it involves expanding the deficit. President Trump hopes to grease the wheels by creating a plan he says will pay for itself, primarily by giving tax credits to the private sector, which he expects to borrow the money to build.  However, Democrats do not support this funding scheme, so support in Congress is low across the board.

Conclusion

A final policy theme to consider is the occasional but persistent antagonism of corporate America by the Trump administration. Donald Trump is less pro-business than he is anti-establishment and pro-working class.  Pushing for job creation, particularly as concerns his core constituency, better supports his popularity than boosting corporate profits, although the two causes can and do overlap.  But where they conflict is where his populism breaks with traditional conservative pro-business policy.  While traditional policy favors carrots, such as tax breaks, in the name of job creation, he favors the stick approach.  When he lashes out at companies who do not comply with his priorities, it hurts their stock prices, because the Presidency is the ultimate bully pulpit.  Considering this prioritization, it would be misguided to assume the uncertain policy questions addressed above will swing to the outcome most favorable to business.

All told, the political change of direction over the past few months has created a lot of issues with serious implications for investors to process. Some are already resolved, others will take years to shake out.  Some developments come as a surprise, others not so much.  A measured approach can help identify which inflections to put to work as opportunities.  The key for investors is to remain disciplined and not get caught up in the whirlwind of possibilities and political promises.
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Martin C. McWilliams III, CFA®
AVP, Associate Portfolio Manager

David M. Kirkpatrick, CFP®
SVP, Portfolio Manager

Charles A. Williams, CFP®,CTFA®
SVP, Portfolio Manager

Brian A. Barker, CFP®, AIF®
SVP, Director of Asset Management