Positive Outlook for U.S. Equities Driven by Expectations of What the Trump Administration Will Do
- Corporate tax cuts, fewer regulations across industries and more spending on infrastructure and defence are potential catalysts for growth
- Repatriation of earnings could lead to increased capex spending and corporate investment
- The underlying macroeconomic environment in the U.S. should support additional growth
- Implementation of new policies will take time to catch up to market sentiment
London, United Kingdom, January 24, 2017 – After the Presidential election victory of Donald J. Trump, U.S. equity markets took an unexpectedly strong upward turn. The Dow Jones Industrial Average gained 1,000 points in a matter of weeks. After signals from the incoming administration that regulation and enforcement will be de-emphasized, banks and financial services stocks surged. Expectations of regulatory rollbacks, coupled with oil prices settled at over $50 a barrel, led energy and exploration stocks to rebound.
After such a fast start, where will U.S. equities go under the Trump Administration? Mr. Trump has made a number of statements over the past year that provides some clues.
“Financial markets have bought into the scenario that corporate tax cuts and reform, together with fewer regulations and more spending on infrastructure and defense, will lead to higher corporate earnings and much stronger growth,” said Hersh Cohen, Co-Chief Investment Officer of Legg Mason affiliate ClearBridge Investments.
“From skepticism and despair last January, markets are now reflecting a great deal of optimism,” Mr. Cohen said. “Whether such optimism is warranted will play out over the next year.”
Enacting Mr. Trump’s proposals will take time, but the macroeconomic environment generally bodes well. On December 14, the U.S. Federal Reserve raised rates for the second time since 2008, and will probably do so again in 2017. With third quarter 2016 GDP growth reported at 3.5%, unemployment below 5% and Fed inflation projections well under 2%, the U.S. economy is poised to continue stronger growth than most other developed countries.
Contrast this healthy outlook with Europe: negative interest rates, post-Brexit uncertainty, weak economic growth and shifting political currents pose strong potential headwinds.
There is considerable skepticism about the short-term prospects for significant appreciation in European equity prices.
Active U.S. stimulus moves could come quickly. Mr. Trump’s promise to spend $1 trillion to shore up the nation’s crumbling bridges, highways, railroads and ports has indications of strong bipartisan support in the U.S. Congress. Consequently, infrastructure stocks could profit.
“Repatriation of overseas earnings, if also enacted as expected by the Republican-controlled U.S. Congress, could boost cash available for capex and other corporate uses such as reinvestment, dividends and share repurchases,” Mr. Cohen added. “These economically stimulating factors may provide support for stock prices and might not send U.S. interest rates much higher.”
If these and other proposed initiatives become reality, it could ignite near-term economic growth, spur employment and prove advantageous to a broad range of U.S. companies, from small caps to the largest. However, implementation could take years to catch up with investor sentiment and the potential damage of Mr. Trump’s protectionist stance to a range of industries is unknown.
“Momentum since the election and pent-up demand from the inhibited environment of the six months prior to it could create a tailwind for businesses in 2017. Employment is strong, and consumer balance sheets are in better shape. Expansionary fiscal policy should ultimately be implemented at a reasonable pace, assuming the conservative Congress restrains spending and does not balloon the federal deficit,” said Bill Hench, Portfolio Manager at Royce & Associates.
“As the new administration populates various agencies, it will be at least into the second half of the year before specific spending plans begin to be implemented. International trade could be subdued while the various participants hesitate until U.S. policy is defined, which could also impede the market’s progress,” he continued.
Mr. Hench believes U.S. equities in general and small caps in particular may rise in the second half of 2017.
“The performance of small-cap stocks depends on a growing economy and higher earnings. We are focused on areas that should ultimately benefit from the tailwinds, including non-residential construction, industrial companies, and technology companies,” he adds. “There are a number of very attractively priced stocks experiencing turnarounds in which we have identified a catalyst for improvement and that we think are likely to benefit from a stronger economy.”
Mr. Trump also has promised to “repeal and replace Obamacare.” If successful, the U.S. healthcare sector could be a primary beneficiary. Pharmaceutical companies, whose pricing Mr. Trump has publicly criticized for the high cost of prescription drugs, could prove an exception.
“While the President-elect has not clearly articulated a healthcare policy, we expect he will lean heavily on the Republican Party’s stance on major health care issues,” said Marshall Gordon, a Senior Research Analyst for Healthcare with Legg Mason affiliate ClearBridge Investments.
“Large-cap biopharmaceutical and medical device companies maintain some of the largest overseas cash balances,” Mr. Gordon continued. “They are likely to benefit from corporate tax reform, particularly repatriation and a move to a territorial tax system. This could provide additional capital to fund research and development, M&A or share buybacks. Increased consolidation could support small- and mid-cap healthcare stocks as acquisition targets.”
“However, should Republicans choose to roll back Obamacare’s coverage expansion, hospitals could suffer. They benefited massively from reduced uncompensated care as coverage, mainly Medicaid, expanded. Hospitals will lose profitability quickly if fewer Americans are covered.”
Mr. Trump’s victory underscored the rise of political sentiment favoring protectionism and middle-income growth, at the expense of economic efficiency and expansion via global trade.
“There is a lot of focus on the downside of populist politics, with no-one talking much about the upside,” said Nick Langley, CEO of RARE Infrastructure, a Legg Mason affiliate. “What comes out of populist politics is a need for governments to start to get ‘looser with their purse strings’ and direct spending toward their local markets. What we could see is that government fiscal spending starts to take over from central banks’ monetary policy. Given that government spending is a lot easier to understand and predict than monetary policy, this could be a very good thing for investors.”
Speculation is rife, but none of Mr. Trump’s promises have yet become reality. This suggests caution, even as conditions appear to favor market increases. At the start of 2016, few expected U.S. equity markets to start a downturn that would culminate in losses of over 20% by February 11. It took until August and September for many stocks to reclaim their 2015 values.
Could that happen in 2017, following the big surge attributed to Mr. Trump’s election?
“When we think about market-moving events, investors often want to react,” observed James Norman, President of QS Investors, a Legg Mason affiliate. “The harder thing to do sometimes is not to react. That’s exactly where we are in terms of making sure that, when we have these types of situations, investors do not overreact. Look at the entire investment universe and keep to your particular discipline – the one you committed to in calmer times – until things become more clear.”
As for what U.S. equity markets will do over the next several months, Mr. Norman declared, “The one sure thing is that we’re going to be accompanied by significantly more uncertainty.”
That uncertainty can lead to opportunity for discerning investors. Diversification of investment exposure to any asset class is a good strategy for long-term success.