9 minute read
From late night tweets to tough talk on trade, Donald Trump’s first year in office has been far from dull. We explore some key developments investors should look out for over the next 12 months.
After nearly one year of watching Donald Trump in his latest role as President of the United States, citizens of the US and the world have settled into the reality of his leadership. At times, he has inspired hope for a new era of US economic and manufacturing dominance. At others, he has instilled doubt into long-standing relationships with the country’s trading partners and traditional allies, contradicted officials in his administration as well as his own previous statements, and stoked outrage with a tacit nonchalance about extremist views.
Depending on your interpretation, US financial markets have either reacted positively to
Trump’s performance so far or been able to ignore his rough edges. Equity indices have pressed on toward new highs, even after the post-election “Trump trade” rally cooled off. Interest rates appear range-bound, despite the Federal Reserve eyeing more hikes in the coming year, while the US dollar has stabilized against major global currencies after sliding through the first three quarters of 2017.
So what should markets be watching for during President Trump’s second year? We identified the 10 issues investors need to have on their radar during 2018.
1. Tax reform
Of all of the initiatives Trump stumped for on the campaign trail, tax reform has been most eagerly awaited by markets. The tax reform bills drafted by Republican House and Senate leaders include many items from Trump’s wish list: lower corporate taxes and simplified tax brackets for individuals, for example. Many of the proposed reform provisions would affect US businesses, including a one-time repatriation of foreign-held profits, a move to a territorial taxation system, and limitations on the tax deductibility of interest payments. The revised rules on foreign profits should encourage US businesses to use these earnings for capital investments or acquisitions, while the change in interest deductibility would make debt issuance less attractive for some companies and alter the dynamics of the US corporate bond market.
“Credit markets are likely to see a material impact from any corporate tax reform that emerges from the negotiations,” says Brent Finck, senior portfolio manager of Global High Yield at Aviva Investors in Chicago. “Of course, it will depend on the details, especially concerning the tax deductibility of interest expense. It could have differing effects on investment grade versus high yield markets.”
Trump has stated he wants to sign a tax reform bill before year-end, and Congressional Republicans appear to be on a fast track to make that happen. But tax reform is complicated and time-consuming; the last major US tax reform effort (the Tax Reform Act of 1986) took over 10 months to progress from bill to law. Plus, support is far from universal; there is active opposition from affected industries, such as real estate and homebuilding, and certain constituencies, including representatives from high-tax cities and states.
US House Republicans passed their tax reform bill on November 16, but as of this writing the Senate’s version remains a work in progress. Tax reform may be the best and only opportunity for Republicans to score a victory they can carry into the 2018 Congressional mid-term elections and that may be enough pressure to make it happen. Markets may have swung too far in unwinding the “Trump trade” and at present are underpricing the likelihood of tax reform becoming law. Even if eventual reform is modest, it could still carry some upside potential for markets.
Trade is one of two issues where Trump found significant electoral support among working class Americans; immigration being the other. Trump’s early actions on existing trade agreements, such as withdrawing the US from the Trans-Pacific Partnership (TPP) and re-opening negotiations with Canada and Mexico on the North America Free Trade Agreement (NAFTA), indicated his willingness to play the anti-globalist card that his base finds appealing. But even in talking tough on trade, Trump can send mixed signals; on his swing through Asia in November, he blamed not China but prior US administrations for the widening trade gap between the two countries, then reverted to protectionist themes when addressing the broader Asia Pacific Economic Cooperation forum.
“Despite the anti-free trade rhetoric of the presidential campaign, and to a lesser extent since, President Trump has not pursued a path of unilateral across-the-board increases in trade protection,” says Michael Grady,* senior economist and strategist at Aviva Investors. “Indeed, Trump’s recent visit to China indicated a willingness to productively engage with those he had criticized most in the past.”
It remains to be seen how effective these statements and actions will be as the administration’s trade policy evolves. US tariffs on South Korean washing machines and British and Canadian passenger jets may play well with American manufacturers and workers, but they can also complicate ongoing diplomatic efforts with key US allies, especially in geopolitical hotspots like the Korean peninsula. There are also US business and political interests, including from Trump’s own party, that favor free trade and would attempt to scuttle any purely protectionist trade actions. Agricultural interests—typically staunch supporters of Republican lawmakers—have been particularly vocal in their opposition to Trump’s early threats in NAFTA re-negotiations.
“The near-term risk is an unravelling in the NAFTA negotiations with the US seeking a number of changes that would likely be deal breakers for Canada and Mexico, such as including a rolling five-year sunset clause in the agreement,” says Grady. “Despite the differences, we think it most likely that a compromise will ultimately be reached.”
Trump pledged to build “a great wall along the southern border”1 with Mexico footing the bill. So far, no funds have been pledged to build a border wall - certainly not from Mexico - and no definitive plans have been put forward either. But Trump didn’t sit idly on immigration during his first year: among other decisions, he restricted the HB1 visa program for skilled foreign workers and, perhaps most notably, moved to end the Deferred Action for Childhood Arrivals (DACA) program, which sheltered approximately 800,000 undocumented immigrant children currently in US (“dreamers”) from deportation.
While these decisions played well to Trump’s supporters, opposition from the broader US public and the business community has been vociferous. The renewed debate could present an opportunity for comprehensive reform of US immigration law in the coming year, but it doesn’t seem likely given the current polarized climate in Washington. “There is no appetite in the Republican party to try to go down the comprehensive [immigration policy reform] road again,” says Edward Alden, senior fellow at the Council on Foreign Relations.2
Trump vowed to repeal and replace his predecessor’s hallmark healthcare coverage law, which he termed “disastrous Obamacare”.3 The three-time failure of the Republican-led Congress to fulfill this vow underscored the GOP leadership’s inability to pass a key component of their party platform and sowed doubts over the likelihood of enacting the rest of their agenda. When repeal stalled in Congress, Trump looked to dismantle Obamacare through the back door, using executive orders to loosen rules on the marketing of health insurance plans and to end subsidy payments to insurers. The president and GOP lawmakers may find other avenues to weaken and eventually cripple Obamacare, by tacking on new rules as amendments in other pieces of legislation as they have done with the current tax reform bill.
“While the GOP has failed to fully repeal and replace Obamacare, we expect healthcare to remain at the forefront of lawmakers’ agendas into 2018,” says Matthew Raque, senior research analyst at Aviva Investors in Chicago. “While parts of Obamacare will be repealed, we still expect the individual exchange markets and state-expanded Medicaid [a health insurance program for low-income people, children and the disabled] to remain in place for the next several years.”
5. Financial services deregulation
Trump enjoys the power of the pen and has used it willingly to revise or reverse a wide range of regulations, from those covering the environment to immigration, without needing to involve Congress. Much of this deregulation effort is being done in the name of preserving or creating American jobs. One focus of this red-tape cutting has been on unwinding many regulations on the financial sector that were put in place after the 2007-09 Global Financial Crisis.
While many of these rules were understandable in response to the banking meltdown, even well-intentioned regulation can hamper financial markets from functioning effectively. It does appear as if the industry is at a high-water mark in terms of regulation. “What is clear is that the administration will decrease scrutiny of and will work to lessen the regulatory burden on financial institutions,” according to Eversheds Sutherland, a global legal firm. “Such decreased scrutiny may introduce problems for cross-border institutions that seek to avail themselves of reduced regulation in the United States while remaining compliant with the regulatory regime in the United Kingdom, where the trend continues to be one of strengthened regulation.”4
6. Infrastructure Candidate
Trump made a point of wanting to build “the next generation of roads, bridges, railways, tunnels, sea ports and airports that our country deserves.”5 US infrastructure remains a nascent market but could be a game changer for investors if Trump delivers a fraction of the infrastructure the US needs. A US$1 trillion price tag for a decade’s worth of infrastructure upgrades has been floated by Trump’s administration, but no concrete plans have emerged as of yet.
Paying for these improvements, no matter the costs, is always going to be a challengefor a government running expanding deficits. To fund these projects, Trump initially had favored public/private partnerships (P3s)—a model used widely among global governments but not as much in the US at the national level. More recently, he has backed away from this idea, saying they were “more trouble than they’re worth”.
“P3s are one tool in the toolkit and they should play a greater part for funding US infrastructure projects,” says Darryl Murphy*, head of infrastructure debt at Aviva Investors. “We have seen a high level of interest from European investors, but the US has proved to be a difficult market to find a sustainable pipeline. This is also made more difficult by infrastructure being delivered at a state and municipality level, with each jurisdiction embracing infrastructure investment with little central support or control.”
7. Federal Reserve appointments
President Trump has an opportunity uncommon for most US presidents to shape the future of
US monetary policy, by filling a number of vacancies on the Fed’s seven-member Board of Governors as well as naming a new Fed chair. Jerome Powell, a current Fed governor and known centrist on monetary policy issues, was nominated by Trump in November to take Janet Yellen’s place at the helm.
“The choice of Powell as Fed chair ensures continuity of monetary policy, rather than change,” says Grady. “His views have been closely aligned to Yellen’s over the past five years, which have no doubt been shaped by the research staff at the Board. I expect the advice to Powell from the staff will continue to be consistent with a gradual withdrawal of monetary accommodation and unwinding of the balance sheet.”
From a longer-term perspective, Trump may be keen to mold a Federal Reserve board that would be more supportive of faster economic growth and maintenance of an accommodative stance toward monetary policy.
“The key appointment to watch for now is the new vice chairman to replace Stanley Fisher,” Grady says. “As Powell is not an economist by training, I expect whoever is nominated for vice chair will be an eminent economist and likely to be more influential over policy than the vice chair has been in recent decades.”
Trump clearly stated his foreign policy position during his inauguration address: “From this day forward, it’s going to be only America first.”6 After one year, it remains unclear how effective “America First” will be for Trump and the US. America’s standing among the rest of the world has taken a hit since Trump took office: the US fell from first to third in the annual Soft Power 30 ranking of global leaders;7 and a Pew Research survey found more people around the world view the US unfavorably now than they did at the end of the Obama presidency.8 Much of this reputational swoon comes as the administration appears less interested in traditional global alliances and prefers to follow a more business-like transactional approach to foreign policy.
Trump is not the first US president to struggle with foreign policy challenges in the first year, so there is possibility a clearer strategy will emerge, especially with the continuing threats of North Korean missile strikes. Melvyn Leffler, visiting professor in World Politics at the Miller Center, University of Virginia, wrote in Foreign Policy: “Forging an effective national security policy is a formidable enterprise, but other presidents have recovered from shaky beginnings. However, it takes more than a formal strategy paper, which this administration, like its predecessors, is now preparing.”8
9. Congressional mid-terms
On the political front, elections for all 435 representatives in the US House and 33 US senators will be hotly watched in November 2018. Right now, Republicans have a 46-vote advantage in the House and a four-vote advantage in the Senate. It would seem the greater risk to the GOP Congressional hegemony would come in the Senate, but Democrats in the upper house actually face the harder road; even with the recently announced retirements of two GOP senators, more incumbent Democratic senators than Republicans are up for re-election in 2018, including many from states that swung to Trump in the 2016 presidential election.
The ultimate outcome of the tax reform bill, after the Senate’s version, if passed, is reconciled with the House version, will be key to many incumbent lawmakers’ re-election prospects.
“The longer the tax reform effort takes, the more likely it is to become a bipartisan effort,” says Finck. “It may come down to those Democratic senators from states with large blocks of Trump voters and facing re-election in 2018. They may be more inclined to support a GOP-led effort with bipartisan proposals.”
Should Republicans maintain their majorities in the House and Senate after the 2018elections, it would bode well for other items on Trump’s wish list to be codified into law. But if emocrats are successful in gaining control of one or both houses, expect legislative gridlock to prevail and the potential for political warfare to erupt between Congressional Democrats and the White House.
10. The shadow of investigations
If all this uncertainty and unpredictability wasn’t enough, there is also the ongoing investigation into Russian-government involvement in the 2016 US election and possible links to the Trump presidential campaign. The grand jury investigation is expected to continue well into 2018, with Robert Mueller, the special prosecutor leading this effort, seeking to subpoena documents and interview current and former White House officials. Whenever news of the investigation breaks, talk of impeachment tends to bubble up. But with Republicans in charge of both chambers of Congress, impeachment is essentially a non-starter.
Anyrevelations from Mueller’s investigation over the next 12 months could change the appetite for what will surely be contentious proceedings. A political war would be likely, with Trump keen to take on his enemies and assured that his base of core supporters will not abandon him. Whether he wins or loses that battle, the other likely outcome from such a battle is a further widening of the partisan divide among the American populace.
* Investment professionals are members of AIA/AIC's Participating Affiliate, Aviva Investors Global Services Limited ("AIGSL").
 Donald Trump campaign speech, Phoenix, Arizona. Sept. 1, 2016.
 “The U.S. Immigration Debate”, Council on Foreign Relations. Updated September 6, 2017.
 Donald Trump Republican National Convention speech, Cleveland, Ohio. July 21, 2017
 “Less is More or More is More? Differences in the Regulatory Ethos in the US and the UK
Pose Challenges for Financial Institutions” Eversheds Sutherland (US) LLP.
Lexology, November 15, 2017. https://www.lexology.com/library/detail.aspx?g=096133c5-c3d0-4201-8a19-2143f24de4f5
 Donald Trump Detroit Economic Club speech, August 8, 2016.
 President Trump Inauguration speech, Washington, D.C. January 20, 2017
 The Soft Power 30: a global ranking of soft power 2017. Portland PR Limited and the USC
Center on Public Diplomacy.
 “U.S. Image Suffers as Publics Around World Question Trump’s Leadership” Pew Research
Center, June 26, 2017.
 “The Worst 1st Year of Foreign Policy Ever” Foreign Policy, September 19, 2017. http://foreignpolicy.com/2017/09/19/the-worst-first-year-of-foreign-policy-ever/
Unless stated otherwise, any sources and opinions expressed are those of Aviva Investors Global Services Limited (Aviva Investors) as of November 28, 2017. Opinions, estimates, forecasts, and statements of financial market trends that are based on current market conditions constitute our judgment and are subject to change without notice. Information contained herein has been obtained from sources believed to be reliable, but has not been independently verified by Aviva Investors and is not guaranteed to be accurate. References to specific securities, asset classes and financial markets are for illustrative purposes only and are not intended to be, and should not be interpreted as, recommendations. Indexes are unmanaged, and one cannot invest directly in an index. They do not reflect any fees, expenses or sales charges. Past performance is no guarantee of future results.
The name “Aviva Investors” as used in this presentation refers to the global organization of affiliated
asset management businesses operating under the Aviva Investors name. Each Aviva Investors’ affiliate is a subsidiary of Aviva plc, a publicly- traded multi-national financial services company headquartered in the United Kingdom.
For Use in Canada
Aviva Investors Canada, Inc (“AIC”) is located in Toronto and is based within the North American region of the global organization of affiliated asset management businesses operating under the Aviva Investors name. AIC is registered with the Ontario Securities Commission (“OSC”) as a Portfolio Manager, an Exempt Market Dealer, and a Commodity Trading Manager.
For Use in the United States
Aviva Investors Americas LLC is a federally registered investment advisor with the U.S. Securities and Exchange Commission. Aviva Investors Americas is also a commodity trading advisor (“CTA”) and commodity pool operator (“CPO”) registered with the Commodity Futures Trading Commission (“CFTC”), and is a member of the National Futures Association (“NFA”). In performing its services, AIA utilizes the
services of investment professionals of affiliated investment advisory firms who are best positioned to provide the expertise required to manage a particular strategy or product. In keeping with applicable regulatory guidance, each such affiliate entered into a Memorandum of Understanding (“MOU”) with AIA pursuant to which such affiliate is considered a “Participating Affiliate” of AIA as that term is used in relief granted by the staff of the Securities and Exchange Commission allowing US registered investment advisers to use portfolio management and trading resources of advisory affiliates subject to the
supervision of a registered adviser. Investment professionals from AIA’s Participating Affiliates render portfolio management, research or trading services to clients of AIA. Investment professionals from the Participating Affiliate also render substantially similar portfolio management research or trading services to clients of advisory affiliates which may result in performance better or worse than presented herein. This means that the employees of the Participating Affiliate who are involved in the management of
strategies and other products offered to US investors are supervised by AIA.
AIA’s Form ADV Part 2A, which provides background information about the firm and its business
practices, is available upon written request to:
225 West Wacker Drive, Suite 2250
Chicago, IL 60606