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Fund managers consider Donald Trump’s next big move

With the new US president sworn in last month, fund managers from a number of asset management houses look at a looming decision over taxation and the potential impact on markets and the economy.

Rob Langston

By Rob Langston, News editor, FE Trustnet
Thursday February 16, 2017

Donald Trump’s US presidency continues to take the world unawares with several controversial executive orders having been issued during the businessman-turned-politician’s initial days in office.

The scrapping of US participation in the Trans Pacific Partnership and the attempt to restrict travel to the US from several countries has alarmed some, despite being among the US president’s election pledges.

With Trump seemingly intent on enacting many of his pledges, fund managers are anticipating the impact of new US policies in the coming months.

Invesco Perpetual US equities head Simon Laing says there have been early signs of the positive impact of a Donald Trump presidency on markets.

“The early economic indicators in 2017 have been solid, and we have yet to see anything that would materially change our view that the economy remains on solid footing,” he said.

“There is now a real chance for acceleration if Trump’s pro-growth policies can be implemented with their desired effect.”

Performance of S&P 500 in 2017

 

Source: FE Analytics

However, Trump’s “unconventional approach to governing” and “unprecedented amount of executive orders signed” will require some monitoring, says Laing.

“Since taking the oath of office we have seen an unprecedented amount of executive orders signed,” he said. “The majority of these are following up on pledges he made in his campaign, so there should be no surprise.”


One of the key areas of interest among fund managers, and one of the next big decisions for the president, are pledges to reform the US tax code, which many believe is overdue.

“We believe the impact from corporate tax reform could be a game changer for US companies, and unlike past attempts, president Trump and a Republican-dominated Congress broadly back reform,” said John Bailer, lead manager of the BNY Mellon US Equity Income Fund.

“The proposed tax reform plan would reduce corporate taxes, potentially lowering them to 20 per cent from 35 per cent.

“This would make America’s tax rate more competitive and virtually eliminate corporate inversions. At present, the US has the highest statutory rate among major countries, so companies tended to hoard cash overseas, which prevented them from returning a meaningful amount of their cash flows to investors.”

Bailer says corporate tax reform could add 7 per cent to the S&P 500 index’s earning per share by 2018 and could entail further boosts for financial sector companies, whose earnings he said could be lifted by 18 per cent.

He added: “Financials earnings should do much better than this as interest rates move higher, regulatory expenses fall and loan growth improves. We believe a few companies could achieve close to 50 per cent earnings uplift from these changes.”

Performance of sector over 1yr

 
Source: FE Analytics

However, reform must be handled carefully, says Invesco Perpetual’s Laing, who argues that any tax cut would need to be funded somehow.

“By using what they call dynamic scoring, the US Congress can basically raise the underlying growth assumptions in their economic models to fund a large part of the tax cut,” he said. “Lower tax rates tend to fuel growth, and that higher growth would pay for some of the cuts.

“But that would still leave a large funding gap in the US fiscal budget, if the tax cuts are to be revenue neutral.

“Neutrality is necessary so not to balloon the budget deficit - doing that would not sit comfortably with fiscally conservative Republicans.”

One way of closing the gap would be to introduce the border adjustment tax (BAT) being proposed by House of Representatives speaker Paul Ryan, says Laing.

The tax would form a 20 per cent tax on revenues from imported goods, but Lain believes “the unintended consequences would be massive”.

“BAT would decimate the retail sector and any import business,” he said. “That in turn would lead to massive job losses and probably push prices higher on key consumer goods, neither of which would have the desired effect of accelerating economic growth.”


While the tax would benefit exporters, Laing says it would have a big impact on importers, such as retailers, and their customers.

The issue of protectionism and favouring of US-based companies was raised during the election campaign, but some believe there are past lessons to be considered.

“Protectionist advocates would do well to brush up on the Smoot-Hawley Tariff Act,” added David Osfield, co- fund manager of EdenTree Amity International fund.

“Reed Smoot and Willis Hawley designed a highly controversial US bill enacted in June 1930, which resulted in the average tariff on dutiable imports to hit 45 per cent. Economists besieged the then president Hoover not to pass the act, but it was signed and had catastrophic consequences.

“The increased tariffs piled economic pressure on to countries during the Great Depression. As a result, banks in foreign countries foundered and international trade nearly ground to the halt, declining 66 per cent between 1929 and 1934, sending the world into economic abyss.

“The international reaction was evident from Canada and Europe via the imposition of a raft of similar protectionist tariffs, which arguably deepened the global depression.”

However, Laing says the potential impact of the tax is likely to be overlooked by the president who has remained sceptical about any implementation of the policy, but highlighted the unpredictability of the administration.

“This president is taking uncharted paths in policy; so unfortunately we cannot write BAT off,” he said. “This is a complicated issue that could cause us to change our views on the US economy and market rapidly.”

He added: “Our hunch is that BAT will not form part of the new tax code, and the posturing is simply part of ‘The Art of the Deal’. We are all still adjusting to president Trump and his methodology, and we do not want to second guess him as yet.” 


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