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Rising US Stock Market Ignores Trump's Failures

Rathbone's Edward Smith reviews President Donald Trump's first 100 days in office and finds the stock market has already priced in tax cuts yet to materialise

Emma Wall 4 May, 2017 | 11:20AM

 

 

 

Emma Wall: Hello, and welcome to the Morningstar series, "Market Reaction." I'm Emma Wall and I'm joined today by Rathbones' Edward Smith to talk about 100 days of Trump.

Hello, Ed.

Edward Smith: Hello, Emma.

Wall: So, we've had 100 days. In fact, I think we've had 103-104 days now. What has happened so far in his presidential?

Smith: Well, if we think about grading his achievements in terms of Trump's contract with the American voter, that really neat sort of political campaigning he released before he became president. That document, on the front page, there were about 18 agenda items that he said he would all definitely get through in the 100 days. And on the second page there were about 10 pieces of more substantial legislations that he said he would quite fight to get through in the first 100 days.

Now, those 18 pieces of sort of agenda items, executive orders, he has probably got through about half of them, Keystone pipelines, executive orders against what former executive employees could do in lobbying jobs after they leave office, drain the swamp that sort of thing. Then the second page, he has achieved very little.

Wall: Now, those executive orders have been a success, but as you suggest, they are more minor items and they get fewer pages in the press. The two big things which we've heard him talk about was his reversal of Obamacare which was less of a success a few months ago. But then last week he came forward with some pretty punchy tax plans, didn't he? Is this the Trump we should expect to see going forward for the next 100 days?

Smith: I think the timing of that was very much about – it was one week to go before 100 days were up and he hadn't really any progress on tax. Trump has always promised tax reform in the mold of Regan. Last week's announcement didn't really sound like reform to me. They were more tax cuts. Now, does he have the backing of his party in order to get through tax cuts of that magnitude. If we tally them up, let's just say they would add about $3.5 trillion to the national debt over 10 years.

Now, remember, that the Freedom Caucus in the House of Republicans wouldn't back his version of Obamacare, his repeal and replace of Obamacare because it was going to add a few hundred billion to the national debt over 10 years. So, if they didn't want to get – if they were so fiscally conservative that they wouldn't vote for that, are they going to vote for $3.5 trillion?

Wall: What about some sort of compromise because I know he came out with a tax cut of around 20% for corporate rate of tax. U.S. corporate rate of tax is rather uncompetitive on a global scale looking at other developed markets. I think it's around 30%-something. He was suggesting 12% to 15%. Is there any chance that they can meet in the middle and this could be one of the things he has actually success at?

Smith: I think there's quite a high chance that they could meet in the middle for sure. So, yeah, statutory rates are around about 37% for a very large company. Now, of course, very few companies actually pay that rate once you take out all the tax breaks. But nevertheless, very uncompetitive level of tax. So, I should think there would be cross-party support to get that through. It's been spoken about for a long time. But I think it will take time.

Wall: I think that's a really important point to make because both S&P 500 and indeed the Russell index, which is the small and mid-sized companies, have rallied significantly since Trump came into power on this expectation that they will see tax cuts and they will have more money in the bank in which to do CapEx, buybacks, dividends. The market has priced all of this in already, has it not?

Smith: Yeah, and that's what makes us at least in the short-term rather nervous or rather cautious about the American market. Now, we don't like going underweight America. America is expensive for a reason. It's always expensive because it has the highest return on equity. It has the best groundbreaking companies year-in, year-out. But at the moment, valuations have really got really quite stretched and even more stretched over the last few months and a lot of that seems to be on this overenthusiasm for what Trump can do in the short term.

The equity risk premium has fallen back to one of the lowest levels we've seen in the last five years. Are we really that much more certain about that much better earnings tomorrow than we have been at any point in the last five years? We don't think that really squares and we think a lot of that is about the Trumpflation trade getting carried away.

Wall: Ed, thank you very much.

Smith: Thanks Emma.

Wall: This is Emma Wall for Morningstar. Thank you for watching.

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About Author

Emma Wall  is former Senior International Editor for Morningstar

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