The Trump rally is not over, but not for the reasons that most investors think. Investors are miscalculating the likelihood of the three most prominent market catalysts emanating from Washington, both positive and negative.
First, comprehensive tax reform is still likely to happen, even as investors and CEOs alike recently have started to throw in the towel on their hopes for a rewrite of the tax code. Chief among their concerns is that this president made the same mistake as the last one, focusing initially on health care rather than going straight to tax reform. They fear that with health-care reform stalled, President Donald Trump and House Speaker Paul Ryan have already lost their legislative mojo.
In an effort to close the deal on the House Republicans' bill to repeal and (sort of) replace the Affordable Care Act, the president posited that there was an inextricable political link between Obamacare reform and tax reform that does not exist in actuality. Even with Obamacare reform stuck in purgatory, tax reform still has its best chance in a generation of being realized. It was a political imperative though that Republicans first sought to dismantle Obamacare after campaigning for the last six years on this promise. This does not, however, make failure of the health-care bill a proxy for a tax overhaul. On the contrary, with the failure to pass the American Health Care Act, Republicans will be even more motivated to achieve a major legislative win via tax reform.
The true challenge with tax reform has been timing. The Senate very well could still not take up its own version of a bill to revamp the tax code until the fall given its lack of progress to date on the issue as well as the impending series of "must-pass" legislative items, such as funding the government and raising the debt limit. But with Trump and Ryan pivoting quickly to tax reform and the Senate no longer stuck wrestling with health-care legislation for the next two months, the markets should take solace that it is now more likely they will have a shiny new tax reform law tucked under the White House Christmas tree this December and less likely that they will have to wait for the Easter Bunny to deliver it next spring.
Second, market participants are over-anticipating, both in terms of timing and magnitude, other major fiscal stimulus measures, most notably infrastructure investment and deregulation.
At the same time that investors are wringing their hands over tax cuts happening, they are irrationally exuberant over $1 trillion in infrastructure investment materializing. The markets view infrastructure as having bipartisan support from the Trump administration and congressional Democrats, but they are misreading the situation. Hill Republicans, who actually control Congress, are not interested in spending more federal dollars on infrastructure projects. Meanwhile, private investment will require a revenue stream, such as a new toll road or airport user fee. Democrats, in contrast, are seeking to repair crumbling roads and bridges, a cost that cannot be recouped by a private investor. Thus, while there appears to be hope of literally bridging the political chasm between the two parties in theory, no such path forward exists in reality.
Another top objective for the Trump administration is massive deregulation. One should not under-estimate the degree of market momentum derived from the certainty that there will not be any new regulations that undercut existing business models broadly across the economy after the eight years of the Obama administration. But investors have also been getting too excited about the extent and pace of regulatory rollback, especially in the case of the banking sector. After all, the Senate still needs at least 60 votes, including the support of at least eight Democrats, to undo the Dodd-Frank Act. Those parts of the economy for which President Barack Obama relied solely on executive authority to regulate, such as the oil and gas sector, are most likely to benefit from President Trump's deregulation.
Finally, the aspect of the new administration's policy agenda, which market participants have had the most difficulty assessing is the mix of protectionist trade, immigration, and national security policy prescriptions that fall under the "America First" umbrella, so they have decided to ignore them altogether. The aggressive economic nationalism championed by White House Chief Strategist Stephen Bannon could trigger an array of significant financial disruptions. Investors, however, consider Trump fundamentally to be a pragmatic businessman at heart who shares their interest in seeing the market rally continue. Inevitably, there will come a geopolitical test that will demonstrate whether Trump is willing to put Bannon's rhetoric into practice. Until then though, the Trump rally still has room to run.
Commentary by Stephen A. Myrow, the managing partner of Beacon Policy Advisors LLC, an independent policy research firm based in Washington, DC. He previously served as a senior U.S. Treasury Department official from 2008 to 2009 under President George W. Bush. Follow him on Twitter @smyrow.
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