Pence Perspectives December 2016
US Election: Clinton Lost, Less Gridlock in WashingtonOn November 9th Donald J. Trump was elected as the 45th president of the United States. He will be the first president with no government or military experience. Unofficial election results indicate that Hillary Clinton got 5 million fewer votes than Obama did eight years ago, the voter turnout in this election was lower than the previous two. This means that the new administration will need to move extra fast to make its mark if it wishes to have long term success. Past experiences show that getting the “big stuff” done in the first 100 days of a new presidency is often the best rapid action strategy because the opposition is still stunned and disorganized. With a Republican majority in both houses of Congress, President-elect Trump will want to take action very quickly before the 2018 mid-term elections, when Democrats will try to regain some seats in Congress. We believe the net outcome of the 2016 election is less gridlock, at least over the next two years.
Bottom Line Up Front:First, President-elect Trump has a very ambitious agenda that he wants to accomplish immediately by the stroke of a pen, via Presidential Executive Order.  He has already outlined 6 items. He wants to withdraw from negotiations on the Trans-Pacific Partnership (TPP) trade deal, cancel many environmental restrictions put in place by President Barack Obama, ask his national security team to buttress against infrastructure attacks, has the Labor Department investigate federal worker visas and impose broad new bans on lobbying by government employees. Second, he is going to try to move through Congress measures he can achieve quickly such as tax-reform, infrastructure spending, and increasing the military budget. For the markets, his policies would affect specific sectors. For example, Trump wants to lower taxes and increase government spending which will likely raise government debt, this, in turn, means higher expected inflation and higher interest rates. Higher interest rates are good for bank stocks and the financial sector. His military and infrastructure spending will mean higher earnings for major defense contractors as well as companies in the industrial, general construction, and construction materials sectors. Furthermore, he will disregard regulations advocated by Hillary Clinton, which may help take pressure off of the healthcare sector, which has been underperforming year to date. His Proposed corporate tax reforms could boost corporate profits. President-elect Trump’s proposal to lower individual federal income tax rates will most likely increase households’ disposable income which means more discretionary spending. Usually, this is positive for companies in the consumer discretionary sector. For the bond market, we will see continued volatility as interest rates rise.
Trump’s Economic PlanPresident-elect Trump wants to grow the economy at 4% per year and add 25 million new jobs over the next decade. The first six items of his action plan should go into effect shortly after January 20th, 2017. Items such as building a wall or fence along the Mexican border, placing new restrictions on immigration, repealing Obamacare, tax reform, and spending $1 trillion on infrastructure will require the approval of Congress and are likely to take significantly more time and work. At first, his jobs goal may seem too ambitious, considering the economy has created a total of 15 million jobs since 2010 after losing 8.7 million jobs during the Great Recession. But his plan hopes to re-engage most of the 14 million people who left the labor force over the past seven years. He believes that for each additional one percentage point rise in gross domestic product (GDP), the economy could add each year an additional 1.2 million jobs. In his tax plan, he is proposing to reduce the corporate tax rate to 15% from 35%, while collapsing the current seven personal income tax brackets to three brackets: 12%, 25%, and 33%. His tax reform plan also caps individual federal tax rate at 33% instead of 39.6% for households whose adjusted gross income (AGI) exceeds $225,000 while increasing the standard deduction for joint filers to $30,000 from $12,600 (for single filers to $15,000 from $6,300). He also wants carried interest to be taxed as ordinary income instead of long-term capital gains. Tax rates on capital gains would be capped at the current rate of 20% and itemized deductions are capped at $200,000 for joint filers or $100,000 for single filers. He’s also proposing eliminating the estate tax, a favorite proposal of small-business owners and farmers who want to pass on their success to their heirs. In order to finance some of his spendings, he is proposing a one-time 10% tax on the repatriation of retained earnings stashed overseas by corporations, estimated to be as high as $2.5 trillion. The President-elect proposes an infrastructure rebuilding plan offering $137 billion in federal tax credits to private investors to unleash up to $1 trillion worth of infrastructure investment over 10 years through revenue-producing public-private partnerships rather than sole government spending. According to the McKinsey Global Institute, the US needs to boost infrastructure spending by 0.7% of GDP between now and 2030 to meet the demands of a growing economy. That equals an additional $130 billion per year over the $416 billion spent by federal, state, and local governments on transportation and water infrastructure in 2014. The President-elect proposes to eliminate the defense spending cuts under sequestration and submit a new budget to rebuild the US military. In his campaign, Mr. Trump called for 90,000 more active Army soldiers, a total of 350-ship Navy, nearly 100 more fighter aircraft, and strengthened nuclear and missile defenses. According to Mr. Trump‘s senior campaign aide, eliminating the sequester would amount to roughly a $50 billion a year increase in defense spending or a $500 billion reinvestment over 10 years. In 2015, the US spent over $600 billion, which is twice the amount spent by all the other 27 NATO countries combined. In order to offset some of the additional cost, Mr. Trump may seek additional payments from countries where the U.S. has military bases, including Germany, Saudi Arabia, and Japan or ask NATO-countries to pay their fair share. The United States accounts for one-third of global defense spending. In fact, we spend more money on the military than the next seven countries combined as shown in the chart below.
When it comes to trade, Mr. Trump wants to focus on the two countries that matter: China and Mexico. The chart below depicts that these two countries account for more than half the US trade deficit in recent years. Mr. Trump wants them to come to the table. With China, he has said he would impose 45% tariff on Chinese imports and declare Beijing a currency manipulator if China doesn’t change its trade practices. With Mexico, he threatened to leave the NAFTA and impose a 35% tariff on imports from Mexico if Mexico doesn’t agree to renegotiate the pact. The truth is these two countries need the US more than the US needs them. In 2015, the US accounted for 80% of Mexico’s exports and 20% of China’s exports, whereas Mexico and China accounted nearly 15% and 8% of US exports, respectively. Negotiating from a stronger position with just these two countries can significantly reduce the US trade deficit.