For the early months of the Trump Presidency, markets screened out the President’s colourful remarks and concentrated on the promised economic, taxation and infrastructure policies.
However, this enthusiasm soon waned as it became apparent Trump’s rhetoric was easier to say that do.
But Rathbones Investment Management chief investment officer Julian Chillingworth says he now sees a greater willingness from both US political parties to get something done.
“It is probably a 50:50 call,” he says. “One issue is with the right wing of the Republican party, a lot of whom have been elected around making sure that the budget doesn’t escalate, and a number of whom come up for election next year. But the mid-terms may also mean they need to demonstrate to the electorate they have achieved something with Donald Trump as a Republican President.”
Big money
Chillingworth says the key elements are a lowering of corporation tax to 20%, a cut in income tax especially for mid ranking earners and a simplification of personal tax.
He adds: “The bit the market is getting very excited about now is the repatriation tax cut to 10% for cash held overseas.”
On a back of the envelope calculation, he says, this cash amounts to $550bn (£419bn €468bn) among the big tech players. Apple has $230bn, Microsoft $120bn, Google $60bn and Oracle $50bn.
He adds: “It’s big money. But what would they do with that money? They will distribute some of that back to shareholders but it is likely that in the package there will be a limitation. There will be a push to get them to invest it in new plant and equipment and probably research. The likes of Amazon and Apple will be keen to be seen putting money into research and possibly buying businesses that will help their research initiatives.”
Matthew Hoggarth, head of research at Thesis Asset Management, says the personal tax simplifications are a sensible idea, but there are many offsetting parts that are likely to make some people better off while others are worse off.
“It is not clear that there will be a net benefit to the aggregate level of consumer demand in the economy,” says Hoggarth. “On the corporate side there is a direct benefit to investors if profits are raised as a result of lower tax liabilities, plus the potential for a long-term growth boost if corporate investment levels rise. The key issue is whether or not this investment is likely.”
Hoggarth believes there is probably enough flexibility in the plans for some kind of agreement to be reached, while the income levels covered by the three new income tax rates are still to be determined and there is scope for a higher top rate if required to ensure the measures are progressive.
“Still, this is not 1986 when the Congress passed President Reagan’s tax cuts,” he adds. “There is much less low-hanging fruit in terms of abolishing reliefs that everyone can agree on, so funding the cuts will not be easy.”
According to Hoggarth, the reform of taxation on overseas profits could be an easier area to find consensus, but this is not guaranteed. He adds the precise level of the minimum foreign tax rate and the question of whether tax would need to be paid on overseas balances that are not repatriated could be significant sticking points if a bipartisan agreement is to be reached.
Will he, won’t he?
Some managers remain deeply sceptical.
Simon Clements co-manager in the sustainable investment team at Liontrust, says: “To date the Trump administration has been wholly ineffective in implementing any of the policy initiatives which had been promised in the lead up to their election victory. Instigating change in Washington requires skilful negotiations, compromise and the ability to forge alliances, none of which appears a particular strength of the current administration.
Clements notes the two key policy changes associated with the ‘Trump trade’ relate to infrastructure spending and tax reform. Infrastructure spending does make sense, he says, but requires an increase in public sector spending, which is unlikely to get voted through a Republican majority.
He says: “Tax reform is a notoriously complicated policy area, but there is always a lot of support for lower tax rates with a Republican majority (and the US does have a very high corporate tax rate) and also unravelling the incentive to manufacture overseas (to take advantage of VAT rebates outside the US).”
“The repatriation of US cash overseas should also be an area whereby support should also be easier to garner, and would undoubtedly be a plus for the US market.
“So we feel a simple tax cut and repatriation is more likely to get passed, and we await details of this. We are still wholly sceptical of the administration’s ability to exact policy change, despite what would appear a policy initiative with a lot of support.”
Long-term shift?
But does the ‘trade’ represent a medium to long term shift?
Hoggarth says this depends on whether lower corporate taxes lead companies to invest in productive capital.
He adds: “President Trump is banking on lower taxes leading to higher investment, greater productivity and job creation. Companies have not been starved of capital previously however. Borrowing rates have been close to record lows and corporate bond markets are thriving. Companies that want to invest are not prevented from doing so.
“In fact, however large amounts of borrowed money have been spent on share buy-backs. These are positive for share prices in the short term, but do not drive long-term growth. If companies spend increased profits from the tax cuts on more buy-backs when market valuations are already high then this is a limited one-off benefit.”
Hoggarth adds a lot of optimism is already baked into current valuations that some form of corporate tax reform will be passed. Additionally much of the benefit of the current plans will flow to SMEs rather than quoted companies, many of whom pay a lower effective corporate tax rate than the current 35% headline figure.
He believes the benefits of the reforms to equity markets are therefore likely to be quite stock-specific and the overall result might not be a refreshed bull market.
“There is always the risk that a failure to pass meaningful reforms could result in a pause in the market’s rise,” he adds.
Chillingworth meanwhile describes the tax rate reduction as “quite spotty”. For example, it doesn’t have much effect on financials. In that respect, it is a one-off boost to earnings and when the market is more certain of it happening will adjust accordingly.
“It is about a 7-8% boost to earnings on the S&P 500,” he adds. “In terms of longer term, any simplification of the personal tax system must be positive for overall consumer spending and for the economy, any cash brought back home has got to be positive.”
Effect on portfolios
When asked will it impact asset allocation Chillingworth says “no” but the Rathbones’ house view in recent years has always been that you need a good weighting in the US, particularly as it gives you investment in types of tech, health tech and to a certain extent media that you cannot get elsewhere.
Hoggarth says if the plans are successful then weightings will certainly need to be reviewed.
“In the best case scenario of a reinvigorated environment of corporate investment and consumer demand in the US, it would not only be US equities that would stand to benefit,” he says. “Equities in other countries could also receive a boost from the higher spending levels if they led to a pick-up in global trade, so relative valuations would also need to come into investors’ thinking.”
For Clements, the focus is on long-term secular changes in the global economy, driven by sustainability themes, which means no trading around policy initiatives.
“We don’t plan any changes to our asset allocation within our global portfolio,” he says.
