Many investors were bewildered by last week’s stock market action.
First, the Dow rallied 400 points on news that the FBI would not be prosecuting Hillary Clinton about her private server, increasing the chance of a Clinton victory.
Then it stumbled on news of her loss – only to quickly rally several hundred points to a new all-time record high in the first two sessions after Donald Trump’s win.[ad#Google Adsense 336×280-IA]Much the same happened overseas.
In Asia, for instance, stocks dropped 5% before seeing the American market’s reaction.
Then they rallied 7% the following evening.
What is going on here? In short, a lot of uncertainty.
No one knows for sure what Donald Trump will do as president.
He made a lot of different (sometimes contradictory) promises during the oh-so-long campaign.
Let’s take a closer look at both the good and bad things we may soon see under a Trump administration…
Healthcare stocks: These rallied for several reasons. No. 1, insurance companies have found it difficult to make money in the new world of Obamacare. (That’s why many of them dropped out of the exchanges.)
Trump promised to “repeal and replace” The Affordable Care Act, and House Speaker Paul Ryan has no shortage of ideas about how to do it. However, healthcare is an enormously complicated sector – thanks, in part, to excessive government interference – and it will be difficult both politically and operationally to revamp a system that may be unpopular but is already well entrenched.
Trump also favors buying insurance across state lines and takes a softer view on drug pricing than Clinton did. So it’s no surprise that pharmaceutical stocks rallied on news of a Trump win.
Defense stocks: Trump talked about bolstering the military. That would be positive for defense stocks. But he also talked about turning more of defense costs over to our allies. So it’s hard to see yet whether this will be a net positive or negative.
Energy stocks: Trump advocated further deregulation of the oil, gas and coal industries. That’s good for these industries but a negative for solar and other environmentally friendly approaches.
Trump also promised to open federal lands to fracking for oil and gas – and to develop the pipeline infrastructure to efficiently transport the fuel.
This not only would make us more energy independent, but would create an enormous export industry.
Financial stocks: Banks and savings and loans were some of the biggest gainers following the Trump victory. The financial sector rallied over 4% on the news. That’s because banks would benefit from less government regulation and higher interest rates.
Why would interest rates be higher? I’ll get to that in just a second.
Utilities: These sold off on the election results. While deregulation would also help here, that consideration was swamped – again – by the likelihood of higher rates.
Bonds: The yield on the 10-year Treasury rose to 2.1% in the aftermath of the election results. (When yields rise, bond prices fall.) This was the biggest one-day yield increase since 2013.
Inflation-adjusted bonds, or TIPS: The inflation expectations embedded in these bonds rose to 1.82% Wednesday from 1.73% Tuesday – further confirmation of the market’s expectation of higher inflation under Trump.
The feeling is that Trump’s tax-cutting proposals, deregulation and potential deficit spending – he is, after all, the self-proclaimed “King of Debt” – would stoke growth but also potentially inflation.
Gold: Gold initially rallied on the news of a Trump victory but then quickly reversed. Gold bugs will have to wait another day for their long-anticipated end of the world.
Infrastructure stocks: This was a rare area of agreement between Clinton and Trump. Both see the pressing need to repair or replace aging roads, bridges, tunnels, ports and airports. Plus, Trump has promised to build “that wall” on our southern border. This would also require more spending and/or more debt.
Again, that could prove inflationary, hence the threat of higher interest rates. That’s the bad news for interest-rate sensitive securities like utilities and bonds.
Of course, not everything candidate Trump proposed is truly business-friendly. His populist rhetoric about renegotiating the North American Free Trade Agreement and the Trans-Pacific Partnership, for instance, comes from a protectionist instinct that plays well to disaffected blue-collar workers but, in fact, would crimp U.S. exports and overall economic growth.
There is one area where Trump, the noncareer politician, can make a truly transformational change: the U.S. tax code.
Trump promised to slash the corporate income tax rate from 35% – one of the highest rates in the world – to 15%, one of the lowest. (This would include partnerships and S corporations that are taxed through the personal income tax code.)
He also called for reducing the top tax rate on individuals from 39.6% to 33%.
However, Trump has a historic opportunity to do something far more significant and long-lasting. In cooperation with the Republican House and Senate, he could dramatically simplify the tax code.
If he merely reduces rates, the next president could easily undo his work. (Just as Trump will quickly undo some of what Obama has done, especially the executive orders.) But if he scraps the entire tax code and replaces it with something fairer, simpler and more transparent, he could ignite growth that would last for many years into the future.
Will he do it? Conservatives have been calling for it not just for years but for decades. Yet under George W. Bush – and a Republican House and Senate – they did nothing of the sort.
Trump claims he will “drain the swamp” in Washington. And nothing is boggier than the infernal tax code, laden with tens of thousands of carve outs and loopholes for special interests.
Cutting tax rates would be ho-hum, conventional. But scrapping the tax code could be truly transformational.
Let’s see if he passes this first important test.
Source: Investment U