With the presidential inauguration just days away, we turn our attention to President-elect Donald Trump's economic agenda and what it may mean for investors.
Most economists expect that the economic policies that have been proposed during the campaign will be priorities, but some degree of bipartisan support — and thus some compromises — will be needed to push legislation through the Senate in particular. Among Trump's key policy pillars are tax reform, infrastructure investment and regulatory reform. Although the Trump agenda extends well beyond the three areas we focus on below, they represent perhaps the most influential factors for the near-term economic and market outlook.
During the campaign, corporate tax reform was one of Trump's central themes. The current U.S. corporate rate of 35 percent is the highest across the developed economies. However, the proposition of cutting it to 15 percent would put it among the lowest, with the stated goal of improving the competitiveness of U.S.-based corporations and creating a tax environment that makes the United States more attractive to global corporations.
Another critical priority is to provide relief to U.S.-based companies with profits exceeding $3 trillion held outside the country. Some bipartisan support exists for a one-time reduction in the applicable rate that would be applied to any capital repatriated to the United States. If successful, it would be a positive development for these companies and the U.S. economy, which could benefit from the influx of capital.
We also expect some changes to individual income and estate-tax policy. A reduction in marginal tax rates has long been expected and is a likely component of the broader package, the details of which are still unclear. Despite this lack of definition, the Trump administration's broad goal of lowering taxes is clear. Questions as to who will benefit and to what extent will be answered in due time.
A major underpinning of Trump's growth and job creation initiatives is his proposal to invest $1 trillion in rebuilding the nation's infrastructure over the next 10 years. Although the plan is still short on details, it appears to be one key policy area in which bipartisan support is likely.
Among the issues that will need to be addressed is finding a palatable way to pay for the plan, which could present a challenge. Nonetheless, the passage of a major infrastructure investment bill will be a high-priority item on the 2017 legislative agenda and one that economists have projected to contribute positively to growth, perhaps as soon as the latter half of this year.
Of the three key initiatives, regulatory reform is perhaps the most difficult to evaluate due to its potential breadth, lack of specifics that have been offered and difficulty in assessing likelihood of meaningful changes or the corresponding economic impact of those changes. Depending on the direction, it also has the potential to have the greatest impact.
While Trump will attempt to advance an agenda to reduce regulation broadly, specifically targeting Dodd-Frank and the Affordable Care Act, an outright repeal of either with no replacement looks highly unlikely, even if that term continues to be used.
Now let's look and see what Trump's policies mean for the economy and for capital markets.
Impact on the economy: Prior to the election, the pickup in the economy was already evident. Estimates vary, but most economists point to a modest increase in GDP in 2017, with the potential for a greater positive effect coming in 2018.
The pro-growth Trump agenda of corporate and individual tax reform, infrastructure investment and regulatory reform all appear likely to provide some near-term boost to economic growth in the United States, although the current lack of details makes any quantitative forecast subject to an unusually high degree of uncertainty.
Impact on fixed-income markets: In the aftermath of the election, long-term interest rates moved sharply higher in response to rising inflation expectations and optimism that fiscal stimulus will drive stronger economic growth in the United States. Short-term rates also rose in anticipation of a December rate hike by the Federal Reserve (which subsequently and, unsurprisingly, became reality) and the central bank's revised expectations for three hikes in 2017.
As the yield curve moves upward, interest-rate risk could create a headwind to the performance of already low-yielding fixed-income securities. Rising rates are a negative for bond performance as it is happening, but over the long term, higher rates will boost the returns of bond investors in the form of higher income. The transition period can be difficult, but the long-term benefit is real.
Impact on equity markets: As already noted, the policies that President-elect Trump has put forward as critical elements of his domestic economic agenda are expected to be pro-growth and thus broadly positive for stocks, and a stronger U.S. economy should provide a more favorable backdrop for corporate America.
While rising interest rates could raise the cost of debt capital at the margins, periods of slowly rising interest rates accompanied by moderate growth have typically provided favorable conditions for U.S. equities. The potential for a continuation of the strong dollar trend and better relative growth in the United States creates an environment that may favor domestic stocks over foreign equities, and small companies over large-cap multinationals.
The unexpected presidential election result and rally in stocks that followed are great reminders of the challenges associated with forecasting. No one — including those in Washington — can say with certainty what will be contained in the legislation that will be proposed, negotiated, adjusted, amended and ultimately passed on to the president for his signature.
Nonetheless, the overall direction of policy in the next administration is relatively clear. The questions revolve around the specifics of what the president and Congress will be able to agree to and implement.
— By Jim Baird, partner at Plante Moran LLC and chief investment officer, Plante Moran Financial Advisors