Trump's First Test And The Markets

The modest corrections in most major financial markets -- flattish stocks/lower dollar and Treasury yields -- since the start of the year fit with the fundamental evidence presented in my January 2 blog.  In line with this blog, the markets are likely to move up this week, ahead of the Presidential inauguration and before uncertainty over Trump's policies becomes a more significant risk overhanging them.

This uncertainty has been exacerbated by Trump's tendency to backtrack from his extreme campaign pledges, making it unclear exactly what he plans to do.  So, the first test for Trump will be whether he demonstrates an ability to carry through with a proposal.  This test should occur within two weeks after the inauguration, as he promised to announce a specific plan to revise/replace ObamaCare during this period.  If he comes up with specifics, the markets are likely to increase the odds that he will carry through with his other proposals.  And, they will likely resume their post-election paths -- stocks, dollar and Treasury yields will climb.  If not, and he loses some credibility, the markets may correct further.

Here are some thoughts on how to view this announcement as well as his other proposals from a market perspective.

ObamaCare Revision/Replacement
The first test of how accurate/serious is Trump's pronouncements will be within a couple of weeks after the inauguration.  He has said that he will announce a plan to replace Obamacare with a "better" plan within that period.  Most of the commentary following this announcement will probably be partisan, with both sides partly correct.  Democrats will argue that fewer people will be covered by health insurance, while Republicans will argue that "skin in the game" incentives will help to hold down health care costs, for example.

This debate would be important with regard to healthcare, itself.  But, from an overall market perspective, the most important aspect of Trump's announcement -- aside from the sectoral/company implications for stocks and corporate bonds -- would be the fact that he came through with a specific proposal.  The latter would give more credibility to his other proposals, as it would stand in contrast to past announcements that appeared to fall short of delivering what he promised.  The markets will be more confident that corporate tax reform, individual tax cuts and trade policy changes will be forthcoming and adjust accordingly.  In contrast, if Trump fails to make a specific announcement, these other policy proposals will be less of a sure thing and the markets could further unwind their post-election moves.

Regarding the overall debate regarding healthcare, my view has been that the cost of ObamaCare is easily handled given how large the US economy is.  The issue is how much society wants to spend on it.  The surveys done in 2009, when ObamaCare was being debated, were not complete.  They asked whether people wanted the various benefits from it, such as insurance for pre-existing conditions and family coverage for members up to the age of 26, but never asked whether they were willing to pay for these items.  The cost aspect of ObamaCare appears to be what surprised and upset people -- suggesting that society is not willing to spend as much as ObamaCare requires.  To be sure, the other side of the coin is whether health care can be made more efficient and thus less costly.  So far, any savings apparently have not been enough to offset the higher costs of the program.

Trade Policy Changes
The worst outcome would be a trade war with China.  This is well-known and thus unlikely.  Trump seems to understand this, as he said the other day that "everything is on the table" with regard to trade with China, apparently backing off from his extreme campaign pledge to impose a large tariff on Chinese imports.  A better outcome would be to obtain changes in Chinese policies that hold back US exports to that country.  Alibaba's offer to encourage US exports to China through its website may be a hopeful harbinger of this possibility.

Restraining Chinese imports is not necessarily a positive for the US.  While some companies and workers would benefit, consumers in general would be hurt by a shift away from low-priced imports to high-priced domestic production.  The extent depends on how far the dollar exchange rate climbs to offset the higher costs.  To be sure, a higher dollar would be a drag on US exports.  So, even if the dollar climbs sufficiently, the net effect on the US standard of living would likely be negative.

Corporate Tax Cuts
There are several macro issues with regard to Trump's proposed corporate tax cuts.  One issue exists with all corporate tax changes -- the split among cuts in tax credits, capital depreciation rules, etc. helps some companies and hurts others.

This disparity will be particularly an issue for Trump's proposal to tax imports and exclude exports.
A number of commentators, like Larry Summers, have highlighted significant problems with this proposal to tax imports.  The drag on exports by the higher dollar that results from this tax does not appear to have been highlighted by them.

Another issue relates to the idea of a tax holiday for corporations to bring home foreign earnings held abroad.  Proponents, as well as the market consensus, argue that the earnings will lead to increased capital investment in the US.  This argument is not correct.  Lack of financing for capital investment has not been a problem in the past few years.  Instead, the absence of strong growth in demand and significant pressures on capacity made capital expansion less necessary.   Generally, an investment decision is made on the basis of its expected profitability, which should not change with the repatriation of funds.

I still like the idea of using the corporate tax code to subsidize labor costs, given Trump's underlying goal of creating jobs.