How can “America First” impact your portfolio?
Six months into President Donald Trump’s first term, many investors are still trying to figure out exactly what his policies will mean for their portfolios.
So far, the surprises have come from the administration, not the markets themselves; the “Trump bump” in U.S. equities and bond yields following the election was a classic example of risk transfer from strong to weaker hands, and stocks continue to discount Trump’s broad mix of policy initiatives on taxes, infrastructure, healthcare and regulations.
Rate markets, though, are another story. Benchmark 10-year U.S. bond yields soared after the election in a broad shift to risk-on trades, but have since ratcheted back down again on the realization that Trump’s policy initiatives will be harder to implement than initially thought. With equities at record levels and U.S. bond spreads back near 2016 lows, resolving this “rates versus risk” question will be a central feature of second-half trading.
“The biggest impact from Trump’s agenda will be tax policy,” said Henry Peabody, a portfolio manager for Eaton Vance. Attendees to Bloomberg’s inaugural Buy-Side Week 2017 New York event in early June heartily agreed, with nearly three-quarters choosing tax reform as Trump’s biggest opportunity to enact policy change. But it’s going to be a wild ride, Peabody cautioned. “The market is setting up for some fireworks in the next six to twelve months,” he added. “We have a market [full] of deep pocketed, price insensitive buyers of U.S. government bonds. Unfunded tax reform will bring much higher rates as we become price makers instead of price takers.”
A large swath of the bond market is wrong-footed, Peabody contended, for the day when volatility rises, although for long-term investors the combination of higher nominal yields with better growth and lower taxes will be a great situation. Importantly, attempts to rewrite the tax code will need to tread carefully around things like the deductibility of interest costs, on which much corporate investment relies and is at the core of private equity and M&A activity. Instead, Peabody expects incentives aimed at investment, such as expensing capital expenditures, which would improve the U.S.’s lagging productivity growth and result in a greater long-term shot in the arm for the economy.
For the moment, Wall Street is largely taking a wait-and-see approach to tax reform because many of the ideas being floated by Republicans, including dramatically lower tax rates, a border adjustment tax, and a one-time levy on repatriation of $2.5 trillion in foreign profits held by U.S. corporations overseas, remain vague.
Meanwhile, Trump’s “America First” slogan is also being felt in foreign affairs and trade policy, and there is a growing consensus that U.S. isolationism will not be a positive for the dollar. “The gap will be filled by China and Europe, which will be a stronger institution for the near term,” argued Peabody. The prospect of broadly lower U.S. influence in the world raises long-term questions about the U.S. dollar’s role as a reserve currency, and leads to a higher euro, while putting a persistent bid underneath emerging markets.
But not all “America First” steps will have immediate consequences for investors. For instance, Miller/Howard Investments portfolio manager, Michael Roomberg, who manages Drill Bit to Burner Tip (DBBDX), an energy mutual fund, believes that while the U.S. decision to withdraw from the Paris climate agreement was geopolitically dramatic, it won’t have much of an impact on the energy sector. “Energy analysts aren’t scrambling to change their estimates for oil, gas or coal as a result of Paris,” he said. “It’s more of a global leadership issue than an energy one. At current gas prices, clean coal is fiction. No investor is going to risk money to build a multi-decade coal plant when this administration may only be there for four or seven years.”
That said, Roomberg agree that energy now has a friend in the White House, which could have strategic consequences for the sector. “The shale revolution happened during the Obama administration, but not because of Obama,” he observed. “The best policy is anything that increases demand, and there is probably no better way to create skilled labor and lower the trade deficit than liquid natural gas (LNG). We have six LNG facilities under construction in the U.S., with each one supporting around 10,000 jobs. It’s one of the few things the U.S. can make that is cost-competitive with the rest of the world, and Rex Tillerson is very aware of this.”
Both Peabody and Roomberg agree that for Wall Street, the elephant in the room is reform of the Dodd-Frank Act, one of the centerpieces of Trump’s effort against regulatory overreach. Despite the early June passage of a House bill repealing Dodd-Frank, neither expects a wholesale rollback to pass the Senate soon. At the same time, rewriting many of the rules put in place to implement Dodd-Frank, including those related to the controversial Volcker rule limiting prop trading, would require coordination between any number of five different government agencies - the Fed, FDIC, the Comptroller of the Currency, CFTC and SEC – in a process that would be neither simple nor quick. Reforming Dodd-Frank “is a big mountain to climb,” said Peabody. “No one is changing their business models based on changes to Dodd-Frank happening anytime soon.”
