Is The Trump Trade Toast?

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Douglas Adams


  • Last week's flame-out of the Republican replacement to ACA seven years in the making was a political setback of unprecedented proportions. The debacle has dramatically realigned market expectations.
  • While the administration turns blithely toward tax reform, without the tax and saving offset from a repealed ACA, a deficit-neutral 20% statutory tax rate is beyond the pale.
  • A BAT tax is highly unlikely to make the final legislative cut, due to growing opposition among Republicans in the House and outright Republican opposition in the Senate.
  • The market glow toward the Trump trade has fallen off significantly since the outsized gains posted after the election through the end of the year.

Last week's spectacular flame-out of the American Health Care Act (AHCA) sent a cavalcade of risk aversion signals cascading through market channels worldwide as investors were unceremoniously forced to recalibrate their now lofty expectations of outsized financial gains in the face of a sputtering Trump economic rollout.

The inability to garner enough support for a Republican draft replacement - seven years in the making - of the much-maligned Affordable Care Act (ACA) in a Republican-controlled House of Representatives bodes ill for an infinitely more complicated tax reform package making it through the House on a similar party-line vote. The US tax code is fiendishly abstruse, with each and every change producing both winners and losers - both of whom are aptly capable of fielding battalions of expertise in support of their respective deduction and/or credit. There is a good reason why the last such Herculean effort at tax reform dates back to 1986. And it goes almost without saying that both President Trump's and Speaker Ryan's consensus and coalition building skills - political competence notwithstanding - are now rather suspect.

That the estimated $1 trillion in tax and spending savings will now not be available from the thwarted repeal of ACA makes the logistics of the Republican tax package making it to the Senate floor on a majority vote all the more difficult. However, let's not put the cart before the horse. We now know there are more than enough Republicans that remain adamantly opposed to deficit additions, which will now almost certainly be the case without the fiscal offset generated by AHCA over the next decade - to kill the bill in a similar fashion as befell AHCA. We also now know that there are numbers in the Republican ranks that are less than inclined to cut the broad and deep reach of Medicaid. Even with an optimistic spin on the AHCA debacle, the CBO estimate of $839 billion savings on Medicaid at the federal level that would reverse the addition of some 14 million people across 31 states and the District of Columbia under ACA over the next decade has now become politically unpalatable.

To make the tax proposal deficit-neutral, the lost funding from the ACA repeal would depend all the more heavily on a border adjustment tax (BAT) generating about $1 trillion over ten years for the tax cut to get anywhere near the 20% statutory tax level being proposed. Currently, BAT carries the lowest probability of making the final legislative cut, particularly in the Senate. Consider the political math: Total retail and food services through the month of February totaled $845.0 billion, according to the US Census Bureau, many of which are heavy importers of foreign goods that would now be subject to BAT, placing already thin margins even further in jeopardy. Such outlets are widely dispersed throughout the 435 House legislative districts. Manufacturing new orders value totaled $235.0 billion over the same period. Manufacturing accounts for about 12.4 million jobs in the US, or about 8.5% of the labor force through February. Retail accounts for 15.9 million jobs, or about 11% of all jobs for the same period.

Without BAT coupled with the tax and spending savings from a repealed ACA, the source of funds to replace the loss of tax revenue to retain a deficit-neutral final product would take years of hard bargaining and consensus building to bring the legislation to fruition - within Republican ranks. Further, the 20% statutory tax rate will almost certainly be much higher due to the lost revenue offsets from ACA and BAT. Democratic support throughout the process is likely to be sparse to nil at best.

Such large-ticket policy statements are almost always conducted in the first 200 days of a new administration, a time when poll ratings and political influence of the newly elected president are both at their heights. It is the time when a newly elected president can call in political favors extended during the long but successful campaign. It is a time when political capital can be spent at its most optimal level. As it turned out, the inexperienced Trump administration squandered 64 of his first 100 days in office chasing a ghost that elicited little support from doctors, nurses, hospitals, insurance companies and, as the CBO analysis bluntly pointed out, would have taken away healthcare benefits from an estimated 14 million people over the course of the next ten years - targeting many of the people who provided the slim electoral difference that put Trump in the White House.

The overriding goals of AHCA were: 1) reduce healthcare costs; and 2) to limit government's role in the delivery of healthcare. That such goals happened to throw people, large number of people, out of insurance pools was an ill-considered consequence of pursuing what was seen as a greater good. The effort backfired miserably on both scores by not assembling the necessary public consensus and building the required political coalitions to push the concept through the legislative process.

Seemingly undeterred, the administration now blithely turns to yet another Herculean task - tax reform. The trouble here is the mid-term electoral cycle rarely extends extra time to make to make one's political case for change, irrespective of size or scope. Steering such a mammoth and controversial tax reform package through Congress in its entirety is now, for all intents and purposes, beyond the political pale. Markets are pricing in this new reality as we speak, while forward expectations adjust accordingly.

Market reaction to this churlish turn of events has been swift. Small and regional banking stocks, huge potential beneficiaries of the administration's tax cut proposals and rising yields, arguably took the first hit. The group collectively soared 26% under the banner of PowerShares KBW Regional Banking Portfolio ETF (KBWR) through the end of the year. The group is now in correction territory, down 11.35% since peaking on March 1. High-flying East-West Bancorp (EWBC) and Signature Bank (SBNY) were primary drivers of the outsized end-of-year gains in excess of 26% and just short of 22%, respectively. Both issues are now powering the decline of the index with losses of 11.27% and 12.10%, respectively.

The Financial Select Sector SPDR ETF (XLF), an index of large commercial and investment banks, paints a somewhat similar story. Tax cuts, deregulation and rising yields create the potential for revenue streams that haven't been realized since the financial crisis. The index was up 17.61% in the final month and a half of 2016, and is now down 4.53% since peaking in the first days of March. Morgan Stanley (MS) blew through the 26% threshold through the end of 2016, only to drop 11.21% through market close on March 27. Bank of America gained almost 33% in 2016 and is now knocking on the door of correction territory, down 9.69% through market close on March 27.

Both the Russell 2000 and the S&P 400 benchmarks for small and mid-sized stocks have experienced the same downward market swoon. The iShares Russell 2000 ETF (IWM) is up 0.52% for the year, after being up almost 11% between the election and the end of the year and up a full 19% throughout the course of 2016. The SPDR S&P MidCap 400 ETF (MDY) is up a scant 2.42% for the year, after being up just over 10% between the election and end of the year and mirroring the Russell 2000 for the year at a 19% overall gain. Both mid- and small-cap stocks are almost universally domestic companies that derive the entirety of their income from domestic sources. Accordingly, a tax cut from the current statutory rate of 35% to the proposed 20% level would drop a substantial sum of newly found funds to bottom lines across the two sectors. The enhancement of business prospects would likely produce a strong bottom-up stimulative effect at the local level, which would contrast sharply with the top-down stimulus orientation of the Federal Reserve since the financial crisis.

The yield on the 10-year Treasury note went from 1.366% in the first week of July to a yield of 2.626% in the first week of December, before dropping as low as 2.348% intraday on March 28 - the lowest yield in a month, and a drop of just over 9%. Projections on the yield for the 10-year note by year's end clustered around the 3% mark at the beginning of the year. With the current yield around the 2.40% level, a 3% note by the end of the year could now be a stretch.

Meanwhile, the US Dollar Index (DXY) was up almost 5% in the aftermath of the election through the end of the year. The dollar is now down 3.30%, having giving up almost all of its gains since the election. In international currency markets, the yen weakened from $105.17 on November 8 to $118.18 by the first week in December. This year, the yen has strengthened against the dollar, from $117.61 at the start of the year to $110.61 intraday (March 28). The euro weakened from $1.1024 in the immediate aftermath of the US election to a low of $1.0422 by the second week of December. The currency has since reasserted itself YTD, largely erasing its losses against the dollar, despite the European Central Bank's (ECB) continuing large-scale asset purchase program that will run through at least the end of the year. Even the British pound, pummeled in the wake of the Brexit vote, made gains against the dollar. Sterling is up 1.39% against the dollar YTD through market close on March 28.

As for the Mexican peso, arguably the biggest causality of the Trump election surprise, it started the year at $20.7385 to the dollar. The peso has since strengthened considerably to $18.8416, gaining just over 9% on the dollar. Its market value ping-ponged against the dollar through much of last year's US presidential cycle, seemingly with each negative Trump announcement on the trade relations between the two countries. With the surprise Trump win, the peso plummeted just over 14% within 48 hours of the election results. The Mexican peso would peak to at least a ten-year low against the dollar on January 19, just before the Trump inauguration.

While world oil prices continue to sag for reasons of excess supply rather than the Trump agenda, the impact of growing surpluses in world crude markets nonetheless continues to dampen prices and, in turn, inflation across the economy. Crude futures for May delivery dropped to $47.89/barrel on the New York Mercantile Exchange (NYME) at market close on March 27. For July, delivery prices remain below the psychologically important market threshold of $50/barrel, coming in at $48.78/barrel. US crude inventory stocks remain less than 2% off an all-time of 545.393 million barrels set on April 29, 2016. US production squeaked above the 9 million b/d mark in February for the first time since March 2016. More rigs continue to be employed in US oil fields over the past 10 weeks, according to Baker Hughes data.

On the international stage, Brent futures for June delivery are at $51.58/barrel on ICE Futures Europe as markets perceive little progress being made on reducing the supply overhang by OPEC's November decision to cut oil production amongst member states. While Saudi Arabia has cut about 800,000 b/d to date, well beyond the 486,000 b/d agreed to in the November decision, Russia has only delivered about a third of the 300,000 b/d reduction promised to date - and that from a much elevated baseline - according to data compiled by the International Energy Agency (IEA). Still, OPEC member state compliance with the November agreement remains surprisingly high at 94%, according to IEA data, signaling more needs to be done to begin the process of shrinking the surplus overhang on world markets. An extension of the six-month production cut in on the agenda at OPEC's May meeting in Vienna.

Through all of this, the VIX remains somnolent, down just over 13% YTD. The measure rose to a reading of 18.74 on November 8 in reaction to the surprise Trump election - as if roused abruptly from hibernation. By year's end, the VIX had dropped to a reading of 14.09, down just under 25%.

Technology issues, never part of the Trump trade regalia have, nonetheless fared well to date. The PowerShares QQQ Trust ETF (QQQ) is up 10.24% on the year. Technology sputtered in the wake of the Trump victory. While straying far from the "America First" mantle, Technology collectively returned a sparse 1.17% from the election through the end of the year. Two of the top three holdings in QQQ mirrored these results. Apple (AAPL) has returned over 23% through market close as on March 27, while managing just 4.29% from the election through the end of the year. Amazon (AMZN) posted similar results, with a 15% increase through market close on March 27, while actually losing almost 5% from the election to the end of the year. Microsoft (MSFT) has only managed a 3.81% return thus far this year and a 2.76% gain from the election through the end of the year.

By far the most consistent gainer in the Trump trade basket of stocks comes from, of all places, the private prison sector. The long, boisterous and contentious Trump conversation on illegal immigration and of building a sea-to-sea wall on the Mexican border has placed a premium on bed counts and detention facilities. The GEO Group (GEO) is up over 26% on the year and a whopping 52% between the election and the end of the year. CoreCivic (CXW) paints a similar picture, up over 26% on the year and over 75% between the election and the end of the year.

Markets are slowly coming around to a more realistic assessment of the Trump administration and its ability to deliver on an agenda that continues to evolve. The lure of tax cuts, deregulation and fiscal spending that made for heady expectations has now descended to more earthly orbits in the wake of the AHCA debacle.

Postscript: The interminable saga of ACA and its maintenance will not end anytime soon. The Republicans brought suit in 2014 to stop government payments to reimburse insurers for subsidies that lowered the cost of deductibles, co-payments and coinsurance for about 6 million people using the ACA exchanges to obtain health coverage. The claim was the executive branch had usurped Congress's constitutional role of approving all appropriations of Treasury funds. Such a reimbursement program was not, it was claimed, in the original ACA bill that passed Congress on party-line votes. A federal judge concurred with the argument in 2016 but let the payments continue, pending appeal. With Friday's failure to repeal ACA, the court case is now center stage.

This article was written by

Douglas Adams profile picture
Douglas Adams specializes in macro-economic research and turning theory into practical portfolio applications for clients over the past seventeen years. Mr. Adams recently formed Charybdis Investments International based in High Falls, New York where he is the managing director of a fee-only investment advisory practice with clients throughout the United States. As an author, Mr. Adams has commented widely on a diverse array of topics from Brexit to monetary policy to forex to labor productivity and wage growth. He holds an undergraduate degree from the University of California, a master’s degree from the University of Washington and an MBA in finance from Syracuse University.

Disclosure: I am/we are long AAPL, AMZN. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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