Penn Mutual Asset Management CIO Mark Heppenstall contributed an article to The Hill where he outlined how the “Trump Trifecta” of taxes, regulation and infrastructure stand to impact markets. The post originally appeared on The Hill on 4/10/17 and can be found below.
Among President Trump’s major campaign slogans was to “drain the swamp” in Washington. Newt Gingrich, one of Trump’s staunchest allies, posted to Twitter following Election Day that “the alligators (in DC) should be worried.” Following a bruising Republican defeat to repeal and replace the Affordable Care Act, the score stands at Alligators 1, Trump 0.
Despite the recent failure on healthcare reform, stock market investors have not given up hope for timely passage of Trump’s other pro-growth economic policies. Stock market performance has so far been extremely resilient in the face of negative news since President Trump took office, even as the ObamaCare repeal and replace legislation looked more and more unlikely to make it out of the House.
However, if meaningful tax reform and other pro-growth policies appear likely to head down the same path, stock market investors will not remain so patient. For investors trying to gauge the likelihood of the eventual implementation of the Trump economic agenda, financial sector performance should be a valuable barometer. Bank and finance stocks are uniquely positioned to benefit from every important part of the new administration’s economic agenda — the “Trump trifecta” of taxes, regulation, and infrastructure.
Bank and financial services companies are clear beneficiaries of the proposed reduction in the corporate tax rate. According to the NYU Stern School of Business, financial institutions, which currently pay an average effective tax rate of 30 percent, would receive an immediate boost to the bottom line with the proposed 20 percent reduction.
Importantly, highly levered banks and financial firms are excluded from a provision in the current House tax plan, which eliminates the deductibility of corporate interest expense. Banks also stand to benefit from the likely boost to U.S. economic growth and investment from a reduction in corporate and personal tax rates.
After the implementation of significant domestic and international financial regulatory reforms after the 2008 crisis — the Dodd Frank Act, Volcker Rule, Basel III — banks were pushed to behave more like utilities and had limited opportunity for growth. Incredibly, Bloomberg found that 30 percent of the rules mandated under Dodd-Frank have yet to be implemented due to the unmanageable complexities handed to regulators. Mounting regulatory compliance costs and stricter capital requirements have also been a drag on earnings for financial firms.
One trillion dollars of new infrastructure spending will support financial firms in two significant areas. First, infrastructure development will support overall economic growth and credit creation. More efficient transportation systems and communication networks in addition to better use of energy and water resources should boost productivity and make companies more competitive. New employment opportunities created as part of the infrastructure spending program should incite consumer spending and borrowing.
In addition, the trillion dollars in proposed infrastructure spending is almost certain to be financed with additional Treasury borrowing. The impact on interest rates is likely to be even more pronounced if the Treasury joins many European sovereign borrowers with 50-year or 10-year debt issuance. The new spending will likely result in higher interest rates and a steeper yield curve, both boosting bank net interest margins and earnings.
The Trump economic policy trifecta — tax cuts, reduced regulation, and infrastructure spending — has already boosted financial sector performance to their highest levels since the financial crisis. Investors need to keep a close eye on valuations moving forward to assess the odds of Republicans finally coming together or simply more gridlock in Washington.