Market forces impacting your planning in 2017 Part III: Politics

In this post, the last in a three-part series, we set out to provide a comprehensive review of current political trends. (Read Part I and Part II in this series.)

How will the political environment impact business in 2017 and beyond?

The new administration will provide perhaps the most dramatic shift in federal policy (from one president to the next) in our lifetime. Within the first 100 days, the president-elect is certain to wield his pen and attempt to unravel many of President Obama’s executive orders.

If Trump’s policies are adopted, one could expect higher inflation, a tightening by the Fed (to counteract inflation) and shrinking labor market (sending wages higher). However, less banking, credit and business regulation could spark greater confidence, and GNP growth. Kiplingers predicts an 11% increase in corporate earnings in 2017.

The president-elect’s most notable actions in 2017 will likely be:

• Free Trade – The Trans-Pacific Partnership is already dead, and the President-elect has said he will “announce [his] intentions to renegotiate NAFTA or withdraw from the deal.” Any government can leave the NAFTA coalition with 6 months’ notice. Trump also threatens to impose import tariffs on Mexico and China. Mexico may be eager to negotiate, with over $24 Billion in annual remittances from those residing in the U.S.  While such action could reverse a slide in net imports and protect American manufacturing jobs, it will also drive up inflation. Some economists believe our economy can sustain price increases in the 1-3% range. Higher prices may actually be welcomed by manufacturers who cannot pass on price increases in a zero net environment.

• Affordable Care Act- A repeal of Obamacare would require congressional action. Lacking a supermajority, congressional republicans will have to negotiate changes to the ACA. With a simple majority, Trump will have the impetus to modify elements such as taxes and spending. More substantive changes would have to survive a filibuster in the senate. Of the law’s most notable features, requirements for the uninsured are very likely to change. The ACA’s underlying economics are not working because too many individuals are paying the fines, insurers are pulling out of the exchanges, and not enough healthy, young Americans are entering the insurance pool to cover pre-existing conditions, undocumented workers, etc. So in lieu of a repeal (which would be impractical), we should expect some tinkering with the incentive system to drive better economics. Private insurers must be motivated to participate in the system for it to work. Expect the advent of more low-quality plans with much higher deductibles – a system that would protect the uninsured from catastrophic health costs, but not cover nuisance claims (one of the factors driving up costs).

• Tax Reform – Both Trump and Speaker Paul Ryan are calling for significant tax reform, including reducing the corporate tax rate (35%). In an attempt to bring taxes back onshore, there could also be a tax amnesty period. Marginal tax rates would be reduced to (12%, 25% and 33%) and both capital gains and dividends to 20%. Trump and Ryan have advocated for a simplification of the tax code. There are calls to eliminate the Alternative Minimum Tax and ACA surtax. Trump has referenced elimination of many personal deductions (to be capped at $200,000 for couples). So marginal tax rates would go down as would many deductions (with the likely exception of mortgage interest and charitable contributions).

• Immigration – The most contentious of Trump’s proposals may be the Deferred Action for Childhood Arrivals program (DACA), a 2012 order by President Obama to allow the children of undocumented workers to stay in the U.S. Unlike other notable policies, Trump’s immigration positions do not reflect new laws, but enforcement of laws already on the books. Therefore, his executive orders and cabinet appointments will affect policy immediately.
  In terms of the effect on business, the wild card is policy affecting labor. According to a study by the National Bureau of Economic Research, a mass deportation could result in an 8-9% decline in production in agriculture, construction and hospitality, industries that employ three million undocumented workers. More troubling, there would be a projected decline of $74 billion in manufacturing output.
  In other words, the combination of more restrictive trade and immigration policies could result in higher prices for manufacturers, tempered by higher labor costs.

• Climate change – If he chooses to do so, Trump could instruct his agencies to not comply with the Paris Agreement on climate change. He could roll back Obama’s Clean Power Plan, elements of which are still tied up in the courts.

• National Security/Military – Iran continues its posturing, declaring that no president can undo the deal to curtail nuclear development. What Trump can do is issue an order for the Treasury to re-impose economic sanctions on Iran’s government, financial institutions and businesses. However, co-signers of the accord such as China and Russia may not participate in sanctions.
  Trump will certainly take a harder line with ISIS, North Korea and others. His cabinet is stacked with military star power. Some are calling for a worldwide coalition to end the bloodshed in the Middle East. Of course, Russia is a wild card, and Trump’s Secretary of State nominee faces a tough confirmation fight.
  Clearly there will be a military buildup, achieved through a rollback of the sequester adopted in 2013. An elimination of the sequester would result in about $50 billion a year in additional spending. Yet, most of the aerospace and defense industry is already at capacity with massive backlogs. During his campaign, Trump called for an increase in the number of ships and submarines, and Air Force fighter aircrafts from 1,113 to 1,200. Trump has called for the reduction in the cost of such platforms.

• The Giant Infrastructure Bill – One of Trump’s campaign promises was to fix the broken U.S. infrastructure, including aging roads and airports. While the cost could be over $1 trillion, Trump views infrastructure as a jobs bill. Look for horse-trading with democrats over the corporate tax rate and other controversial issues. While the reduced labor pool will be a constraint to the construction industry, this bill will provide a boom to engineering and contractors for roads, bridges and the like.

• Appointees
  Above and beyond the standard Cabinet appointments, Trump will likely shape the Supreme Court. In addition, he is expected to appoint four members of the Federal Reserve Bank, which will probably need to raise rates in the face of higher inflation. Also, republicans want fewer bank regulations but higher reserves (which will reduce risk).

But we believe the greatest economic impact from this election has already occurred. The Dow hit a record 19,778 on December 12th, reflecting newfound optimism on the part of investors. The dollar is on a roll. If the capital markets continue to thrive even under the threat of higher interest rates, there could be a spark in the economy in 2017-2018.
Meanwhile
Europe’s influence is waning – Brexit, the U.S. election, and referendums in Italy and France represent a fundamental shift and rising nationalism.

As a result of Brexit and diminished influence in Germany and elsewhere, Europe’s economic output is being overshadowed by Asia. For the first time, 2017 will mark the year when the Asian continent produces twice the output of Europe.

China’s bubble could burst – China’s debt-to-GDP ratio rose 28% within the last year. Real estate prices are rising at rates similar to the U.S. before the liquidity crisis. China is propping up growth in any way it can.

Xi Jinping is consolidating power in the Communist Party, but does not seem willing to impose necessary reforms. As economic growth slows, China will impose even greater nationalism (as in the case in North Korea) to distract from the country’s slowing economy and poor human rights record. Such posturing could position China for a showdown with the United States, triggering a dangerous game of chicken.

The next flashpoint could be in South America – Fidel Castro’s death has occurred during a time when the balance of power could be shifting in Central and South America. In Venezuela, socialism is failing in the wake of massive inflation and food shortages. Fidel was the symbolic leader of a movement that could be reaching its natural conclusion. It could also provoke a humanitarian crisis.

Strained racial relations – O.J. Simpson is eligible for parole in October 2017. His potential release will spark more debate, just in time for next November’s election.

With the potential of tax rates contracting in the future, management teams should talk to their CPAs about deferring income into 2017. Companies that are confident about their growth may consider additional spending in sales and marketing. Banks, which will be less regulated and lending at higher rates, will be thriving again.

Tighten your belt for 2017; it is going to be a wild ride.

Read Part I and Part II in this series.

Read more on this topic: Post-presidential election survey: Economic analysis for CEOs and business owners

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