The Trump Bandwagon – A Note Of Caution On Spiraling Enthusiasm

Dirk SteinhoffExpert predictions and dire warnings of markets tanking should Trump be elected have all been proven spectacularly wrong. The reaction we saw instead quickly came to be referred to as “the Trump rally,” with the S&P 500 bouncing back to record highs.

Stock market euphoria continued in the weeks following the election, sustained by the new President-elect’s cabinet picks and his confident twitter-delivered statements. As Figure 1 below shows, the markets have spoken: Investors have put their faith in Donald Trump and in his pledge to “make America great again”.

Instead of rushing in to join the celebrations, we want to make a case here for remaining temperate. We’ll consider the merits of a “wait and see” approach, of prioritizing facts over promises, and explore the reasoning behind a conservative and responsible wealth planning strategy. Tempting as it might be to jump on the bandwagon, it is important to remember that markets are a voting machine in the short term, but in the long term, they are a weighing machine.

trump_rally

From theory to practice: A bumpy ride

Many practical challenges lie ahead for Trump’s administration and his policy platform. For one thing, Trump can expect fierce opposition from the Democrats, who will undoubtedly place obstacles in the way of his making the changes he promised on the campaign trail. Whether it comes to repealing Obamacare, building “the Wall”, infrastructure and defense spending, tax reform, renegotiating NAFTA, etc., all will require support from Congress. In theory, under the current Republican majority, he should have the votes. However, many of his proposals face opposition even from within his own party, which could present serious challenges to fulfilling his vision.

Nevertheless, even if the new administration does manage to overcome such obstacles, and Trump finds himself in the position to freely lead the country in the direction he envisioned, it might not necessarily be good news for investors or the economy in general.

Tax cuts: Small details, big impact

Although the prospect of tax reform has been welcomed by the markets, Trump’s exact plan remains unclear. Steven Mnuchin, his nominee for the post of Secretary of Treasury, confirmed that the specifics of the new tax law will be clarified after negotiating and working together with Congress. It could therefore be premature for investors and business owners to factor in the campaign trail promises to their financial planning process.

Even if the new tax system is indeed enacted as described in Trump’s last relevant campaign speech, the middle class would indeed benefit, but only modestly, according to a recent analysis by the Tax Policy Center. By contrast to the campaign narrative, tax experts across the political spectrum agree that Trump’s tax plan would benefit the richest Americans the most. Warren Buffet’s Berkshire Hathaway, for example, stands to benefit from a $29 billion increase of its book value under the proposed tax cuts, according to Barclays.

Overall, Trump’s tax reform, as presented, would provide a major boost to corporate bottom lines and to the stock market. Nevertheless, it remains to be seen if, how, and by how much the individual investor would benefit.

The cost of bringing jobs back to the US

Trump has adopted a clear “carrot and stick” approach to persuading companies to reversing the trend of shipping jobs overseas, and to increasing their reliance on domestic resources instead.

The “carrot” he offered was reduced tax rates so that companies can avoid having to pass the extra costs down to their customers. We saw this strategy cross over from theory into practice in the successful Carrier deal, as Trump persuaded the company to keep 1,100 jobs scheduled to move to Mexico at its Indiana facility.

Although the deal was used as evidence that Trump’s promises will be kept, many critics have raised doubts about the economic soundness of the move. By indirectly subsidizing these 1,100 jobs through tax breaks, the new administration is distorting market dynamics. The deal uses taxpayer money to support the increased cost of producing an air conditioner in Indiana instead of Mexico, and thus, even if it is not added to the price tag, the consumer still pays the extra cost.

Despite all the unintended consequences of the “carrot” element of the job repatriation plan might involve, the “stick” has drawn even harsher criticism. Trump has directly threatened companies that will not “comply” with a 35% tariff: “Please be forewarned prior to making a very expensive mistake” tweeted the President-elect, sending a stern message to companies should they choose to reject his invitation to bring jobs back to the US.

Not even his supposed allies, the Republicans in Congress, could stomach this solution of selective tariffs on imports from specific companies. House Majority Leader Kevin McCarthy has made it clear that he will not back this plan, as did Republican Senator Ben Sasse, who argued that the policy would effectively impose a 35% tax on American consumers.

Trade war fears

Trump has recently stated that the US should look at trade “almost as a war”, to the dismay of many of his critics who have repeatedly expressed concerns that the President-elect’s tough talk on trade could trigger a trade war with another country. Also, his repeated threats to impose tariffs on Chinese goods, along with his unexpected call with Taiwan’s leader (a provocative move from China’s perspective), have done nothing to ease fears of trade tensions ahead.

Indeed, as can be seen in Figure 2, the US has lost more than 5 million manufacturing jobs since 2000, partly because of increased automation and partly because of corporations choosing to ship jobs to lower-wage countries such as Mexico, India, Pakistan and China.

US_manufacturing_jobs

However, the aggressive policies that Trump has proposed could easily backfire. Any tariffs, whether they are imposed on a single company or on an entire industry or country, could easily escalate and culminate into a trade impasse: a lose-lose situation for all parties involved, with consumers ultimately paying the price. China, Trump’s favorite campaign target, has made it abundantly clear that it would retaliate against unilaterally imposed tariffs (possible “counterstrikes” include devaluation of the Yuan, introducing new rules that make it harder for American companies to get their profits out of the country and canceling orders from US manufacturers, e.g. Boeing).

Hoping for the best, preparing for the worst

The future of the US economy, and its impact on the rest of the world, is in a state of flux. Too many open questions and little clarity over the actual plans and the practicalities of the Trump administration’s policy direction make it impossible to accurately predict the net effect of his presidency. Of particular concern is the fact that Trump’s recipe to “Make America Great Again”, as presented during his campaign speeches, relies heavily on government spending, infrastructure projects and rebuilding the country’s “depleted military”, as Trump himself put it. This, combined with the promised tax cuts, translate into a sharply increased deficit.

The new President-elect will be taking over a federal government that has been on a “debt binge” ever since the financial meltdown of 2008: Federal debt has climbed from 35% of GDP in 2007 to 74% at the end of 2015. Many experts already predict that Trump’s plans and policies would take US debt to record levels. As veteran investor Bill Gross pointed out, investors “must consider the negatives of Trump’s anti-globalization ideas,” while he also warned that the Trump presidency would only add to the “long-term global debt crisis.”

Whether the new administration’s plan will benefit individual investors remains to be seen. For the time being, all we know for sure is that Trump has a bumpy transitional phase ahead of him, and so do the markets, when the rally corrects, and enthusiasm subsides. Nobody can tell where the economy will stand when the dust settles. Even if Trump can ultimately successfully steer the US economy on a solid growth track, the process will most likely be protracted by bureaucracy and political opposition, and the market will take time to adjust to the “new normal,” whatever that might practically look like at the time.

Therefore, now is the time for planning ahead, to protect one’s assets against the uncertainty of the year, or even years, ahead. A responsible, conservative wealth planning and investment strategy, based on geographic diversification, would dictate that preparations are made and key steps are taken during the “good times”. By the time the winds have changed, and the excitement has soured, it is usually too late.

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