US Markets rally to Trumps low tax and high investment agenda
- Monday, May 22, 2017
Donald Trump vowed to ‘rebuild America from the ground up’. With Republicans now in control of both Chambers of Congress, he has the mandate to push ahead with few obstacles in his way. This will avert the past paralysis and obstruction that limited President Obama and would have also awaited a President Clinton.
There may be friction between the central personalities who failed to support Donald Trump but House Republicans will hardly resist his plans to cut corporation tax from 35% to as low as 15%. He is likely to gain support for his plans to replace the current seven tier income tax system with a three tier system and in doing so cut income tax from 39% to 33% for the rich, to 25% for middle earners, but increase tax rates from 10% to 12% for the less well paid. Republican are not likely to block his calls for a spending spree on bridges, tunnels, telecommunications, cyber security, water systems, pipelines and the electricity grid. Infrastructure built by American workers using American materials.
Donald Trump looks to have taken a leaf out of Ronald Reagan’s philosophy of getting government out of the way of business and cutting regulation and taxes. Trump is also adding stimulus in the form of significant infrastructure investment to improve productivity. Financial markets are becoming encouraged by Trump’s proposed infrastructure spending. Stocks and bond yields have risen and when adding this to tax cuts, we can expect economic expansion.
America’s infrastructure is in a poor state after many decades of relative neglect. A large taxpayer funded or private sector funded road and bridge building programme would be a boost for jobs. For a country with high employment, the unemployment rate is currently 4.9%; the outcome is likely to be growth and inflation.
Trump understands that a 35% rate of corporation tax is very high by international standards. The equivalent UK rate is currently 20% while in Ireland it is 12.5%. This is why so many US companies are now based in Ireland to the annoyance of US politicians. American growth has been affected by their high tax rates and a cut to 15% would be a major boost to investment and production.
The Tax Foundation has suggested that the combined effect of the potential changes in corporation tax, the new incentive for US business to repatriate capital and a simplified income tax system could boost US GDP growth by 6.8% over 10 years with wages rising 5.5% and stock values 21% over the same time scale. The last time the US unleashed a fiscal stimulus when the economy was not in recession was in the early 80’s this pushed up the value of the US$ and forced the Federal Reserve to raise interest rates to control inflation.
Tax reform seems to have been one issue that has eluded the US for some time. The greatest tax cut killer is uncontrolled public spending and heavy deficits. For Trump to deliver on his tax reforms, he will need to control public spending. The most costly of which is welfare and pensions at 33.6% and health care at 26.6% of Federal spending.
A major concern to environmentalists is Mr Trumps view on global warming. He has stated that global warming is an ‘expensive hoax’. His ‘America first energy plan’ seeks to access further untapped shale, oil and natural gas reserves as well as reduce energy regulation and lift the moratorium on energy production on federal land.
What ramifications this policy may have on the global price of oil is unclear but with general demand falling as technology improves oil is unlikely to see significant growth from the US$54pb mark that it is currently trading around after the recent OPEC production level agreement. The challenge for oil producing countries and oil companies alike is there is an expectation that most cars will be electric within 15 years. Currently 70% of oil production goes towards transportation.
With the dust settling over the election of Donald Trump as US President, Wall Street has responded positively with significant gains in industries and sectors that could benefit from the proposed fiscal stimulus. By 1st December both the S&P 500 and the Dow Jones indexes rose to a twelve month high of 2199 and 19191 respectively. Generally, there has been renewed optimism with sectors such as construction, healthcare, banking and defence doing well.
The value of the dollar strengthened as markets digested how Mr Trump’s policies could impact growth. The pound also gained and recovered lost value against both the US$ and the €. The fall in the € has much to do with the impact that Brexit and Trump has on the Italian Referendum on 4th December, the Netherlands General Election on the 15th of March and the French Presidential Election on the 23rd of April.
Trumps potential policy changes of cutting individual and corporation tax, spending US$550bn on infrastructure and boosting American military capacity are likely to give rise to inflation. This revival in inflation expectations has seen the US 10 year Treasury bond yields rise to 2.3% from 1.8% pre-election. Yields on US 10 year Treasuries are the benchmark price for global money. Any rise will have an impact of forcing up yields in both sovereign and corporate debt in the rest of the world. When yields are raised to counter inflation invariably bond prices will fall to compensate. The resulting price fall saw US$1tn being wiped off global bond prices as yields around the world followed suite.
The American economy added 176,000, 191,000, 161,000 and 178,000 new jobs in August, September, October and November with average wage growth rising too. This is helping to pick up household spending but US inflation remains steady at below the Fed’s 2% target even if other measures of inflation are rising. This allows the Fed to be patient and if need be hold back on any further interest rate rises.
However, most economists expect Janet Yellen to announce a rise in Federal interest rates. A rate rise is as much about dampening inflationary pressure due to the steadily improving job numbers as it is about the Fed’s credibility to act. Donald Trump has heavily criticised the Federal Reserve for keeping interest rates low and creating a “false economy”. This may also put pressure on the Federal Open Markets Committee (FOMC) to act on December the 14th.
The Fed does want to get ahead of the inflationary pressure curve and return America to normalised economics. If rates do rise, then there will be an impact on businesses around the world leading to a recalibration of borrowing costs and rising bond yields. Rising US$ values and higher interest rates will hurt emerging market economies. The MSCI Emerging Markets Index fell 7% in the week after the 8th of November US election.
Higher interest rates around the world will lead to higher borrowing costs. With national, corporate and household debt at near record levels, the outcome may have some unintended consequences.
The outlook for the US economy looks attractive and therefore even at its current high value the US stock market is worth supporting along with specialist infrastructure funds. However, we are concerned about the trade protectionist stance taken by Trump. If Trump were to launch a trade war against China and Mexico with a tit-for-tat tariffs imposed on imported goods, then the fall out for the global economy would be devastating. The world cannot deal with an all-out trade war as this would result in mutually assured destruction and therefore is highly unlikely.
Generally, there has been renewed optimism with sectors such as construction, healthcare, banking and defence doing well
Chris DaviesChartered Financial Adviser
Chris is a Chartered Independent Financial Adviser and leads the investment team.