Orlando's Outlook: Election was all about the economy

11-22-2016

Bottom Line As we approach the sacrosanct Thanksgiving holiday weekend here in the U.S., what we as a nation are collectively most thankful for this year is an end to the ugliest presidential election in history. To be sure, Donald Trump’s surprising victory over Hillary Clinton initially stunned voters and investors alike. But over the ensuing fortnight, as investors have begun to process the fiscal-policy implications of a Republican sweep, the financial market’s interim report card has been enthusiastically supportive of our country’s decision at the polls:

  • The S&P 500 hit a new record high yesterday, soaring by more than 8% on a futures basis and by more than 5% on a cash basis, over the past two weeks.
  • Benchmark 10-year Treasury yields have spiked from 1.77% to a peak of 2.35%.
  • The U.S. dollar has risen more than 6% against the euro, from 1.13 to 1.06.
  • The volatility index (VIX) has plunged 47%.

While the prospects for a more vibrant economy have certainly encouraged many Americans, a variety of social concerns associated with a Trump victory have also driven others into a heightened state of panic and anxiety. Regrettably, we’ve seen violent protest marches across the country in New York, Chicago, Los Angeles and Portland, and a plethora of social-media attacks. What sort of social-policy concerns are giving us angst? A potential rise in sexism, racism, homophobia and xenophobia, resulting in the mass deportation of illegal immigrants, discrimination against the disabled, a loss of reproductive rights for women and a rollback of same-sex marriage rights, among many other fears.

This is all very troubling to us, of course, and we do not believe that Americans who supported the Republicans in the election also support the implementation of heinous social policies such as these. We simply do not believe that women, African-Americans, Latinos, Muslims, immigrants, the LGBTQ community, the disabled and others are all in the social policy cross-hairs of the incoming Trump administration. Rather, this election, in our view, was all about strengthening our economy, defense and health care, not rolling back a century or more of societal progress. It is our fervent hope that we can all find the abundant, unbiased good in our country over Thanksgiving, and begin the critically important process of healing as a nation.

New Rust-Belt troika sets the tone We envision a CEO-style of presidency for Trump, in which he will establish a broad vision, and delegate the execution of the critical policy details to the experts. To that end, the Republicans have an important new legislative-policy triumvirate in Washington to help achieve their goals, led by Paul Ryan, the current speaker of the House of Representatives, who is from Wisconsin. He will be joined by the new Vice President-elect Mike Pence, who was the governor of Indiana, and by Reince Priebus, Mr. Trump’s newly appointed chief of staff, who was the Republican national committee chairman during the election, and who also hails from Wisconsin. In the aftermath of this “change” election, in which voters opted for a different course of action to help strengthen the economy, we believe that this Midwestern power troika will attempt to focus on these legislative priorities:

Corporate tax reform The U.S. has, by far, the highest combined federal corporate tax rate in the world at 39%, versus an average of only 22% for the 35 industrialized nations who comprise the Organization for Economic Cooperation and Development (OECD). Ireland is at the other end of the tax spectrum at 12%. Moreover, the U.S. is one of only six OECD nations that still maintains a worldwide taxation system (versus a territorial system), which taxes income only once, in the country where it was earned.

What might corporate tax reform in the U.S. look like?

  • Lower corporate tax rates to at least 20% That brings the U.S. rate down to a level below the OECD average, eliminating the global competitive disadvantage in which our U.S.-based companies now find themselves.
  • Eliminate tax loopholes Makes the tax code fairer by leveling the playing field. Many U.S. companies pay taxes at a rate substantially lower than 39%—some even pay nothing—because our complicated tax code is riddled with loopholes and deductions, which specifically benefit some (but not all) industries and companies.
  • Broaden the corporate-tax base Clean up the tax code so that more companies will pay taxes, perhaps with a minimum rate, so we could actually generate more federal tax revenue by lowering the rate in a stronger economy.
  • Territorial tax system Tax companies only once, in the country in which the revenue was earned, and then allow companies to bring that net income home without additional domestic taxes.
  • Repatriation Bring home $2.6 trillion in cash sitting on overseas balance sheets.

Reduce regulations Washington has gummed up the works over the past eight years by piling on mountains of unnecessary regulations, grinding corporate investment spending to a halt. In the financial services industry, for example, we might see a freeze on the new Department of Labor rules, a watering-down of Dodd-Frank, less SEC enforcement and stronger oversight of the Consumer Financial Protection Bureau. Energy and industrial companies have been hurt by heightened environmental rules by the EPA. So we might see the approval, for example, of the Keystone pipeline.

Fix the inversion problem Because of the wide disparity in high corporate tax rates here compared with the rest of the world, a U.S.–based company will often acquire a foreign company from a low-tax country, covert it into a subsidiary and then transfer all of its patents and other intellectual property (IP) to the foreign subsidiary. The subsidiary then “lends” the IP to the parent company, so it can legally retain its IP at a significantly lower tax rate.

While the Obama administration claims such companies are unpatriotic, the senior management teams of these businesses have a fiduciary obligation to enhance the value of their company. In 1986, according to the Wall Street Journal, 218 of the world’s 500 largest corporations as measured by revenue were based here in the U.S. Today, only 128 companies are, costing the U.S. jobs, economic activity and tax revenue. There’s bipartisan support in Congress to change the tax code to remove the threat of inversions due to this extreme difference in tax rates. Lower tax rates will fix the problem.

Deemed repatriation U.S. companies continue to defer the repatriation of their foreign-sourced income, which now totals an estimated $2.6 trillion in cash equivalents on overseas balance sheets, according to the Joint Committee on Taxation. While many companies would love to bring their overseas cash home to spend and invest, they will not do so at a tax rate of 39%.

The creation of a territorial tax system resolves the problem of how to tax companies doing business overseas. To unlock the cash that’s currently stuck on their overseas balance sheets, Washington is discussing a mandatory repatriation tax rate of 7.5% (within an estimated range of 5-10%), which would generate a corporate-tax windfall for Washington of approximately $200 billion. With interest rates still relatively low, the Trump administration could do a bond offering or create an infrastructure bank to inject $1 trillion over 10 years into meaningful construction projects to fix our crumbling infrastructure. Projects could include a national rollout of a GPS-based air-traffic control system, new airports, roads, bridges, tunnels, trains, ports, electrical grids, and water and sewage facilities.

That would leave $2.4 trillion in available cash for U.S.-based multi-national companies to bring home to spend and invest in:

  • Mergers and acquisitions
  • Share repurchases
  • Dividend increases
  • Research and development
  • Corporate capital expenditures, such as new property, plants and equipment
  • Increased hiring and wages

The combination of government-sponsored infrastructure spending and corporate investment would, in our view, collectively boost economic and corporate-earnings growth and financial-market performance, particularly if the Trump administration allows the immediate expensing of corporate capital expenditures. For those concerned that companies would use all of their repatriated cash to pay dividends or repurchase shares, we could set limits as to how much of the deployed cash can be allocated to financial engineering and for enhancing operations.

Stronger defense In a classic “guns versus butter” trade-off, the Obama Administration reduced spending on defense 19% as a percentage of GDP from 2009 to 2014, redistributing those dollars into social programs. President Bill Clinton had similarly reduced defense spending during his two terms in office from 1992 to 2000. However, due to increased instability in the Middle East and the growth of ISIS, Congress began to restore those defense cuts in 2015 and 2016, when the Republicans reclaimed governing majority. We expect the Trump administration to continue in this more recent path, restoring a more muscular defense by adding to both troop levels and weapon systems. This will improve our defense infrastructure and further boost economic growth.

Fix health care This was one of the central issues of the election, as many voters were unhappy that under the Affordable Care Act (ACA), premiums, deductibles and copays were soaring, while insurance companies, hospitals and doctors were leaving the system. Yet, one of the central tenets of the program was a success, as 20 million more Americans have health insurance.

We expect to see several of the popular aspects of this program remain in place:

  • Allow the newly insured to remain in the program in transition.
  • Keep children on their parents’ policy until age 26.
  • Prevent insurance companies from discriminating against pre-existing medical conditions.
  • Prevent insurance companies from artificially capping the amount of money they spend annually on a patient’s medical care.

But there are several financial improvements that we expect the Trump administration to explore:

  • Sell insurance across state lines to increase competition, improve quality and lower costs.
  • Tort reform, to reduce the practice of defensive medicine, which drives up costs.
  • Reduce the insurance subsidies from families earning $100,000 now to something closer to the poverty line at $25,000.
  • Eliminate the individual mandate.
  • Create high-risk pools to insure the very sick.
  • Expand and reform Medicaid and Medicare, using block grants to the states.
  • Restore the definition of full-time work hours from 30 to 40 per week.
  • Allow the sale of cheaper catastrophic-care plans, rather than mandated, high-cost blue-chip plans.
  • Allow tax credits for individuals who purchase insurance privately outside of work.
  • Restore health-savings accounts at higher levels.

Immigration works President-elect Trump expects to add 25 million jobs to the economy over the next decade, which translates into adding an average of 208,000 workers to the nonfarm payrolls each month, which is a manageable goal. But with the birth rate in the U.S. currently at its slowest pace ever at less than 0.6% annually, it’s unlikely that we can achieve that goal longer term without a constructive immigration policy. So while we do expect a greater emphasis on border security and tighter vetting for new immigrants, we do not expect to see deportation squads remove an estimated 11 million illegal immigrants here now in the U.S., as many are gainfully employed in the agriculture, hospitality and child-care industries. In addition, we would also expect to eventually see an increase in the H-1B skilled-worker visa program. Some three-quarters of the candidates for advanced degrees at top universities in the U.S. are from abroad. Encouraging those highly educated and skilled individuals to remain here to launch their careers would fill open jobs and boost economic growth.

Conclusion One of the hallmarks of our great nation is the peaceful transition of power from one party to the other every four years, after a free and open election. Let’s hope that the end result of this year’s election is a healthier economy, a stronger defense and a working and more affordable health-care system, without the sacrifice of any of the wonderful social progress we’ve made over our history.

Happy Thanksgiving, everyone!

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