19 January 2017
In the giddy aftermath of the US presidential election, investors and strategists scrambled to reassess virtually every assumption they hold. This is understandable, but too much of the commentary has been overly specific. The journey from manifesto and steakhouse promises – “we’ll get your taxes down” – to investment decision appears alarmingly short and in some cases devoid of analysis.
It makes sense instead to step back and consider what would constitute truly successful US economic policy and whether President-elect Donald Trump can deliver it. Mr. Trump has set himself a target to at least double the growth rate. But taking GDP growth back to 1990s levels of say 5% will not be easy. US – and indeed global – growth has been held back in recent years, principally by a lack of productivity growth and a shrinking labour force. Investors therefore need to make a judgement on whether reversing these two trends is within the capabilities of the new administration, since that will surely inform long term asset allocations.
Part of the challenge investors face in making an informed assessment is the lack of concrete policy detail over how much campaign rhetoric will translate into action. Unlike most presidential candidates, Donald Trump has no political experience, so there is no congressional or senate voting record to analyse.
Some preliminary conclusions can however be drawn. First, it is highly likely that government spending will increase, not all of which will be fully funded. This economic stimulus will come in the form of infrastructure rollout and the additional private demand accruing from lower corporate and personal taxation. In the short term this is likely to sustain positive sentiment, with knock-on effects for the stock market. Government bonds will likely continue to suffer as yields move upwards to adjust for increased issuance as well as higher growth and higher inflation expectations. On the latter, the US is already at full employment and would struggle to generate the labour ‘supply’ to meet the increased demand that more spending would entail. The adjustment mechanism would inevitably be higher prices.
So the markets should continue to discount these trends as policy is fleshed out and confirmed. But looking beyond the initial period of adjustment, most serious estimates of the boost to growth from such stimulus are more conservative than President-elect Trump’s “4% or higher” target. The Obama package of 2009 was estimated to have delivered 1.7% of additional growth which faded after three years. Every stimulus eventually has to be paid for, which suggests either tax rises or spending cuts down the line, with a correspondingly dampening effect on growth.
Supply side reform, or deregulation, appears to be the other centrepiece of Trump economic policy. The President-elect recently promised to remove two regulations for every new one created. This might sound like a gimmick, but evidence suggests that a deregulation agenda could form the foundations of better economic performance. The market has certainly taken kindly to the prospects of even a partial repeal of the Dodd-Frank reforms, with US financial stocks soaring relative to the rest of the market. Healthcare stocks are also relieved to be spared Hillary Clinton’s corporatist interventions.
However, a more profound - and overlooked - regulatory issue for the US economy is the growth of occupational licensing. One recent study estimated that licensing restrictions were costing millions of jobs and raising consumer prices by over USD100 billion. This was raised by the supposedly regulation-mad Obama administration, but the Trump campaign has been remarkably silent on the issue. This may change but the key lesson is that deregulation is about much more than repealing laws unpopular among certain sectors of the economy.
Taken together, these two broad policies of stimulus and deregulation are likely to boost growth somewhat and maintain positive investor sentiment for now. But it’s not clear that productivity will rise or that the labour force will meaningfully grow. So far, the argument has been that lower taxes will prompt an investment revolution. But the evidence does not consistently support this, particularly given the record of ‘repatriation holidays’ when companies with overseas cash piles were granted temporary tax amnesties but did not go on to allocate the gains as anticipated.
Similarly, it’s hard to envisage how the incoming administration could reverse the adverse demographic tide sweeping America and indeed most western economies. Immigration would be the obvious recourse, but that will not be an option for at least four years. On this basis, it’s difficult to conclude that President-elect Trump’s economic agenda provides a realistic chance of restoring US economic growth to former glories.
Put simply, he is a generation too late to deliver what he aspires to. The world has changed profoundly since the 1980s when there was little need to worry about demographics and policymakers could instead focus on the benefits that tax simplification and other deregulatory reforms could accrue. These remain valid strategies for any new president to promote but on their own they are not enough. Those who bet big now on truly era-defining moves in the major asset classes may be disappointed by the spring. Instead, a tactical approach to equities and bonds, married to a portfolio core which focuses on long term, independent drivers of return, is more likely to deliver superior risk-adjusted returns.
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