Since his inauguration on January 20th, Donald Trump has dominated headlines across the globe with his flurry of Executive Orders and Memorandums. If there were any nagging questions from the populous as to whether Trump was only posturing to his constituents during the election with his bold policies, they have now been put to rest. Whether you agree with Trump’s policies or not, it seems as though he intends to carry out his stated agenda during his time as President.
Many in the media have suggested that these policy announcements are the signs of an unpredictable man, yet seemingly to the contrary, the orders passed into law thus far were foreshadowed in his 100-day plan and on the campaign trail. Whilst somewhat erratic and unpolished in his politicking, his plan is available for all to see.
Figure 1. Trump’s contract with the US voter
First, a look at the main orders and memorandums he has passed so far:
- ‘Minimizing the Economic Burden of the Patient Protection and Affordable Care Act Pending Repeal’ This order was designed as the precursor for the repealing of the Patient Protection and Affordable Care Act, more commonly known as ‘Obamacare’. This was a policy that Trump repeatedly attacked on the campaign trail and included mention of in his contract. The Executive Order is presumably the first step to what the document describes as a ‘full repeal … and replace it with Health Savings Accounts, the ability to purchase health insurance across state lines’. This of course raises questions as to what will happen Americans from lower socioeconomic backgrounds with existing conditions when the new legislation comes into effect, yet health-insurance executives and their companies’ share prices have certainly reacted positively (as well as experiencing above expected revenue growth and raising interest rates). Obamacare proved to be an expensive affair for insurance companies, with some of the nation’s largest such as UnitedHealth and Aetna losing upwards of $500m per annum on the program. UnitedHealth had previously indicated in 2014 that it intended to discontinue offering Obamacare coverage in various states do to its high level of losses from the program.
Figure 2. 2014 Changes to ObamaCare that prompted insurers to pull out from market
Source. Wall Street Journal, McKinsey & Co.
- ‘Expediting Environmental Reviews and Approvals for High Priority Infrastructure Projects and Reducing Regulatory Burdens for Domestic Manufacturing’ This order was designed to reduce the amount of time that infrastructure projects take to be approved by environmental agencies and the level and intensity of regulation that manufacturing is subject to. Again, this throws up questions as to the potential environmental impacts (Deepwater Horizon and James Hardie come to mind), it will also save companies a significant amount of money. For example, a 2013 paper by the National Bureau of Economic Research suggested that environmental regulations were potentially costing the U.S. manufacturing 8.8% of the sector’s cumulative profits.
Figure 3. Congress passed legislation vs. Agency passed rules and Cost per employee of regulation
Source. Competitive Enterprise Institute and National Assoc. of Manufacturers
- ‘Regarding Withdrawal of the U.S. from the Trans-Pacific Partnership’ as the title reads, this memorandum officially instructed U.S. federal bodies to cease negotiations with foreign nations in regards to entering into the TPP. Given it was negotiated under the White House and never ratified by Congress, there will be little immediate economic effect of the decision. Since the announcement, other cornerstone partners of the agreement such as Japan have said there is little desire to continue the trade deal without the inclusion of the U.S.
- ‘Regarding Construction of American Pipelines & Regarding Construction of the Keystone XL Pipeline/ Dakota Access Pipeline’ Both of these pipelines have been under significant scrutiny from environmental and various action groups due to the perceived threat it posed to the water, air, soil and animal life nearby. This was further complicated by Native Americans who have tribal land on the proposed path of the pipeline. TransCanada, the company behind the Keystone Pipeline, has been invited to reapply for permits from the White House on the condition that the pipeline exclusively uses U.S. steel and parts for construction. There have been some disagreements between various groups as to the actual amount of jobs the pipelines would create, with company estimates at around 28,000 during the construction phase and the State Department (under Obama) estimating as little as 4,000 jobs. The true number most likely lies somewhere in the middle, but further jobs would likely be added at the Texas refineries where the crude oil is set to flow.
- ‘Protecting the Nation from Foreign Terrorist Entry into the United States’ This E.O has caused the largest international outcry to date, with many world leaders expressing their indignation. Confusion reigned in the 24 hours after the E.O., with reports of American dual citizens being seized at airports, pilots unsure if they would be able to fly into U.S. airports and families travelling overseas unsure if they would be allowed back to their homes. Some sense finally surfaced with the White House clarifying that green card holders and dual nationals would be exempt from the ban. The move caused some jitters amongst travel and airline stocks in the market, though nothing substantial.
Assuming Trump continues with his current path and looks to fulfil each of actions on his contract; some of the policies we can expect in the coming months include:
- Direct his Secretary of Treasury, the recently appointed Steve Mnuchin (ex-Goldman Sachs), to label China as a currency manipulator, whilst directing Treasury to identify other nations doing the same. This was originally a promise that Mitt Romney made when running against Obama in 2012, saying such a move would allow him to place tariffs on industries where he believed China was gaining an unfair advantage. While making no specific mentions of placing tariffs on China in his voter contract, Trump did so verbally multiple times during the campaign. Such a move, whilst seemingly positive for America in isolation, would almost inevitably lead to a tit-for-tat political standoff with China and other countries – leading to a deterioration of conditions for the global economy. Considering U.S. corporates have the highest percentage of foreign earnings in the Western world, this is a policy where an overly aggressive change could have significant downside for the U.S. economy.
- Use a combination of E.Os and laws through Congress to lift restrictions on the production and exploration of shale, oil, natural gas and coal. This carries on from the expedition of environmental E.O and will likely reverse a number of decisions from the Obama administration which limited the ability of companies to build shale oil wells on public land as well as off Alaska and parts of the Atlantic. Questions may again arise about the potential environmental consequences of such a move, but it would also likely raise oil production in the U.S., generate jobs and a boost to economic growth.
- Reduce the amount of payments that the U.S. makes to U.N. Climate Change programs. The U.S. had previously pledged $3b to the U.N. Green Climate Fund, which had in total about $10b in future commitments from developed nations and a target of $100b by 2020. With the U.S. pulling out, it certainly would spell trouble for the fund which has significant investments across the globe in green energy. The majority of the fund’s projects are in developing nations in Africa and Asia-Pacific.
- Cancel all federal funding to sanctuary cities Sanctuary cities are cities, counties or states that protect illegal immigrants from deportation by limiting local cooperation with federal authorities. There are currently 300 cities and counties across the U.S. that identify as sanctuary cities, as well as the entire states of California, Connecticut, New Mexico and Colorado. Whilst both Bush and Obama both had historically elevated levels of deportations during their tenures (2m+ each), both claim that the majority were those who had committed crimes. If Trump empowers federal immigration services to request papers and find illegal immigrants before they come onto law enforcements radar, he could potentially remove large amounts of the U.S. workforce who are currently working under the minimum wage. This would have various effects on the businesses that rely on them for cheap labour as well as the cost of goods (often agricultural) that they sell into the economy.
Figure 4. Deportations from the U.S. by year, figures in thousands
Source. Washington Post & Department of Homeland Security
- The proposed policy that has seen the most pushback from the business community, specifically tech companies, is the proposed E.O. changing the workings of the H-1B visa system. Similar to Australia’s 457 visas, their stated purpose is to allow companies to hire high-skilled foreign workers where a shortage of such workers exists. Trump argued during the campaign that the system was being rorted by companies to reduce wage costs to their businesses rather than filling shortages. The proposed changes leaked to the media suggest Trump will focus on giving priority to the companies who are hiring workers with the largest wages, given the system has previously used a lottery-quota system. As per the infographic below, this change would have a significant impact on the listed Indian outsourcing companies, whilst potentially increasing the amount of H-1B workers companies like Google and Facebook could employ.
Figure 5. Top filers for H-1B visas and comparison to FANG stocks
Source. Department of Labor & Axios
Executive Orders, whilst a way for Trump to push through some of his stated policy objectives, will not suffice in making all of his proposed changes to U.S. legislation. E.Os still must abide by the Constitution as well as, after Supreme Court clarification during the Korean War, the broad intent of Congress. At the time of publishing this report, there have been 13 individual lawsuits filed in various states against the immigration order, with almost all citing the violation of religious and due process rights.
The biggest resistance to Trump’s stated policies may come from his $1t infrastructure spending plan, combined with significant corporate tax cuts. Whilst it is likely that Trump will find support from the Republican dominated houses for his tax plan, it may prove a more difficult to convince certain wings of the party to substantially increase government spending and deficit. The Tea Party Caucus currently has 4 members in the Senate and 48 in the House, enough to stymy the path of legislation if they vote as a block. Given market multiples have generally held towards all-time highs, on what appears to the pricing in of these tax cuts and fiscal stimulation, valuations will be extremely susceptible to news regarding the timing and implementation (or lack thereof) of these initiatives.
Measuring political risk is a tricky proposition and markets have historically had a poor track record when pricing it into assets. Policy changes and directives often catch markets by surprise and can have both substantial downside and upside risk. We only need to look to the last couple of years to see a number of times when government actions have affected markets:
- Push for gun control laws in the U.S. as well as anticipation of such laws after high-profile attacks
Figure 6. Smith & Wesson’s share price annotated with various high profile gun attacks
Source. Google Finance & The Guardian
- Banning of private prisons at the federal level in the U.S.
Figure 7. Correction Corp’s share price post DOJ announcement
Given the quantum of changes proposed by Trump and the uncertainty around fiscal stimulation and tax cuts, combined with the rise of nationalist parties across Europe, we feel it is appropriate to be carrying a higher level of cash in our portfolios. While it appears certain that political risk is on the rise, it is also important to temper one’s view of the apocalyptic undertones of various commentators in the media with a more partisan view on the potential effects of announced policies (a hard thing to find at times!).
Whilst VIX has been trending towards 2007 lows, we believe there is a level of complacency baked into the market that may not be completely justified. This is exemplified by the significant premium to historical valuations at which the market is trading. We believe that the current political climate will ultimately give rise to volatility and present opportunities to patient investors – especially amongst the entrenched large caps with proven long-term business models and consistent earnings and dividends. In an era where single tweets can move market valuations by billions in a matter of seconds, it would be a prudent decision to keep some fuel in the tank in anticipation of these sorts of events.