Letter from America - part three: Are markets over-optimistic on Trump's finance, energy and infrastructure policies?
UK equity fund manager David Docherty recently visited the US to discover more about the new Donald Trump administration and its likely impact on markets. In part three of his findings, he discusses domestic policy areas including infrastructure and energy.
Unstructured Learning Time
- Dodd-Frank will not be overhauled any time soon but an easing of enforcement and a reduction of bureaucracy in financials should be very positive for bank lending.
- Domestic energy production will be stimulated by Trump and will help deliver energy independence, investment, jobs, lower pump prices and increased US industrial competitiveness.
- There will be legislative and financial limits to Trump’s ability to deliver on his infrastructure promises. Some building and construction stocks now look vulnerable after outperformance.
Lending a hand – financial services
Candidate Trump spoke often about his desire to tear up the Dodd-Frank framework of financial regulation but repeal is unlikely any time soon given other priorities.
In a touch of irony, the current conventional wisdom is that many of the larger banks are not particularly in favour of Dodd-Frank’s repeal. This is largely because they do not want to take on the challenge of charting their way through a new regulatory rule book.
Nonetheless, a relaxation of regulation and enforcement is very much on the cards, thereby reducing firms’ compliance burden and encouraging greater lending activity.
In terms of personnel, a key appointment will be a new vice chair for supervision, the key financial regulator at the Federal Reserve (Fed). The slot is currently vacant with the regulatory role being discharged by Fed Governor Daniel Tarullo, someone widely viewed in financial and conservative circles as too interventionist.
An appointment of a less activist vice chair would thus be well received by markets in general and financials in particular. This reduction of bureaucracy would likely aid the critical transmission mechanism of lenders, notably the community banks, providing credit into the economy and should therefore be growth-friendly.
To the extent that this abets the normalisation of government bond yields, the banking sector should start to make improved returns. On this basis, generally low valuations should provide a favourable basis for continued outperformance despite the sector’s recent rally.
Oiling the wheels – energy
Energy is crucially important to Trump and will be a significant determinant of the success or otherwise of his presidency. In short, he will stoke the domestic hydrocarbon boom in order to deliver energy independence, investment, jobs and cheap gasoline.
The resultant economic activity should be sustainable in the sense that it involves not just companies’ exploration and production investment but also the longer term boost to US industrial competitiveness of lower energy input costs.
His intentions on energy are clearly outlined in his 2016 book Great Again: How to Fix our Crippled America. He argued that “we need to reduce our foreign oil dependence considerably” and proclaimed that “our first priorities need to be approving the Keystone XL pipeline and starting to drill everywhere oil is accessible”.
To this end, Trump has signed executive actions to start negotiations on both Keystone XL and the Dakota Access pipeline projects. The appointments of Scott Pruitt at the Environmental Protection Agency and Rick Perry at the Department of Energy will serve these goals while the selection of Rex Tillerson, former chairman and CEO of Exxon Mobil, as secretary of state also demonstrates that Trump is well disposed towards the oil industry.
It must be noted that certain projects depend on state rather than federal permission and there will be environmental objections. However, the Trump administration will encourage an attitude of “drill, baby, drill” and this should be very supportive for the profits of oil service companies.
This increased activity is a potential depressant for the price of oil and is a counterweight to the price-supportive impact of OPEC’s recent supply cut. This helps to inform our general preference for oil drillers over the oil producers.
On renewable energy, Trump has spoken dismissively about wind and solar in the past but some observers have suggested that a left-field development might be a more friendly view on alternatives than currently expected by investors. This will be worth monitoring and has plausibility in that the government might view wind as a job-friendly, “Made in America” infrastructure effort.
Bumps in the road – infrastructure spending
In Great Again, Trump jokes that “there are some things so obvious that Joe Biden can see them” and refers to the fact that America’s infrastructure is “crumbling”. Indeed, in his victory speech on 9 November 2016 he promised “to fix our inner cities and rebuild our highways, bridges, tunnels, airports, schools, hospitals”.
To this end, his nominee for the post of transportation secretary, Elaine Chao, has promised to set up an infrastructure task force but any further progress looks unlikely to be within the first 100 days as Trump had originally wished.
This is a function of the numbers game discussed in part one of this Letter, with the scarce resources of votes, money and time being applied instead to the key priorities of taxation and healthcare.
Although Trump sees an important role for private money through public-private partnerships (known as P3) and the use of tax credits, there is likely to be opposition to increased spending from conservative Republicans in the Republican Study Committee and Freedom Caucus.
While it is true that infrastructure spending will increase if economic growth picks up, we believe it is important to be vigilant on the valuations of construction and building materials stocks which have performed particularly well in the wake of the election.
If you want to learn more on how Trump's presidency might affect your investments: