What Do Trump's Cabinet Designees Tell Us?

With another 7 weeks before the beginning of the new administration, the president-elect has now made clear his choices for the key roles in his economic team. We can now draw some conclusions on what direction policy will likely take in his new Administration. 

Let me begin by saying that his choices suggest to me that Trump will likely make a good attempt to enact the agenda he articulated during his campaign. Specifically, I think it’s realistic to expect that he will look to pursue an industrial policy that seeks to encourage domestic manufacturing, renegotiate major trade agreements, reduce tax rates and reform the tax code. His choices suggest that he does not intend to hand over the reigns to subordinates, but rather people who are likely to be less independent than many expected.

Given the fact that the Republicans now have control of both the congress and the presidency, it’s realistic to expect that most of the new president’s appointments should be confirmed by the senate. 

But, this does not mean that the appointments won’t face come challenges. Each appointee will go through committee hearings and questioned by Democrats. And it’s also important to note that Trump will continue to face continued hostility from most of the major media outlets, including the financial media (in particular, the Wall Street Journal, Bloomberg and CNBC.) This can be attributed to Mr. Trump’s history and style, but also due to substantial ideological disagreements on issues of trade and regulatory policy that he has with financial industry leaders in the media and in business. Trump also faces substantial resistance from members of his own party who strongly opposed him in his rise to power and who have relative security in their positions (e.g. Sen. Lindsay Graham of South Carolina and Megyn Kelly at Fox News.)

That having been said, the following appointments suggest significant changes are coming.

WILBUR ROSS, SECRETARY OF COMMERCE

Ross is a highly prominent hedge fund manager and frequent contributor at CNBC. A billionaire, his background is largely in using leveraged buyouts to turn around distressed businesses and he had a strong association with the coal industry. While Commerce Secretary has often been a somewhat irrelevant role, his choice indicates there’s strong reason to believe that Ross will be a major player and spokesperson for the administration. Ross, like Trump, is known for his some heretical views on trade policy - where he’s argued that a large trade deficit is a major concern and an indicator of unhealthy trends, something that’s a fairly rare perspective among mainstream Republicans. Ross has not held positions in government previously, but his frequent public comments have suggested that he will also favor an agenda of  bilateral trade agreements, as opposed to regional ones like the Trans-Pacific Partnership which dominated the Obama Administration’s agenda for the last few years.

STEVEN MNUCHIN, SECRETARY OF THE TREASURY

Mnuchin was a virtual unknown before having taken over as head of Trump’s campaign finances. A former Goldman Sachs banker (something that has been endlessly observed by Trump’s opponents), he also has an extensive and varied history in business, including working as a spectacularly-successful Hollywood producer and in the mortgage business. While little is known about Mnuchin’s views, his comments so far have given some guidance; Specifically, he’s indicated that the administration will pursue a tax overhaul that will be largely revenue-neutral, with simplification and elimination of deductions offsetting cuts in rates. 

What Mnuchin’s selection largely indicates to me is that Trump intends to exert a highly active role over Treasury policy and Mnuchin is expected to be a loyal subordinate. 

JEFF SESSIONS, ATTORNEY GENERAL

This will be Trump’s most controversial pick because he represents the far right on most issues related to immigration, drug policy and most social issues. Sessions will be leaving one of the safest seats in the US senate and enjoys a position of independence of power that’s far greater than any of Trump’s other designees so far. This should be encouraging to (but not completely reassuring of) those who are concerned that Trump will use the executive branch in a highly personal way to strike out at his enemies.

Less examined is Sessions’ views on economic issues, which will play some role in his position. Notable is his opposition to the Bush Administration’s 2008 Troubled Asset Relief Program (a.k.a. bailout of the banks) and his 100% rating by the National Federation of Independent Businesses. It’s safe to assume that Sessions will be largely favorable to business interests - particularly those of small companies. 

WHAT DOES ALL THIS MEAN FOR TAXES?

There exists an opportunity, unseen in nearly thirty years, for a widespread overhaul of the tax code. While meaningful reforms were passed in 2003, the last time the code was meaningfully overhauled was in 1986. There is widespread consensus that an overhaul is preferable and most of what has been suggested is just that. More so, the new president will likely be able to get reforms fairly easily through the congress. What Trump has proposed would mean that, by most analyses, significant cuts for most clients’ (and most Americans) taxes. Particularly significant is the proposed elimination of the Alternative Minimum Tax (AMT). However, secretary - designee Mnuchin has also stated that the administration does not intend for the reforms to translate into an “absolute cut for the upper class.”

The experience of the 1986 cuts was that a major overhaul will result in both winners and losers. For some clients, there will undoubtedly be major implications - as there were especially for real estate investors in the wake of 1986. Most notably, Trump’s agenda would limit deductions to $100,000 for single filers and $200,000 for married. It’s reasonable to expect that certain communities, like real estate investors, will find the administration’s legislative goals are highly aligned with theirs, where others (perhaps venture capitalists and hedge fund managers) might not see their interests well represented.

At present, and most obviously, the most substantial tax cuts would emerge would be the cutting of the corporate tax rate from 35 to 15%, which would apply (according to the campaign) to small businesses as well. This would be a huge cut for small businesses and would likely have significant long-term impact on the self-employed and those in partnerships. It seems likely that many client’s in unusual tax arrangements will need to adjust their tax strategy accordingly.

What if Clinton Wins?

Is it a third Obama term or something entirely different?

Hillary Clinton has been the favorite to win the presidency for most of this election cycle. Recent polling reinforces that perspective. Indeed, if the most recent polls are to be believed, Secretary Clinton looks to win in a landslide and the Democrats will establish a majority in the Senate, while increasing their number of seats in the House. While much of her campaign has sought to capitalize on the general popularity of President Obama, there are some meaningful differences in both circumstances and policy that will mean certain departures from the status quo. 

THE TECHNOLOGY SECTOR WILL LIKELY CONTINUE TO BENEFIT FROM THE CURRENT ENVIRONMENT

One area unlikely to change is the technology sector. While Secretary Clinton has made some statements in the past about her concerns regarding the “gig economy” and the labor practices of certain technology companies like Uber, she’s unlikely, I suspect to upset a relationship that’s been highly beneficial to the Democrats and which has been one of the strongest points in the US economy. This generally means a more favorable environment towards mergers and acquisitions, and a continued soft approach towards labor issues. The net result is continued profitability and favorable trends in terms of valuation. In particular, a Clinton presidency is likely to be good for social media companies. (Although many of the industry’s internal forward challenges still remain…)

A MORE HOSTILE ENVIRONMENT FOR THE TRADITIONAL ENERGY SECTOR IS ALMOST GUARANTEED

The same cannot be said of the energy sector. While unlikely to be able to reform the tax code in a meaningful way without control of the House, and somewhat limited by Bush era laws that limit the federal government’s ability to regulate energy production, there are several ways that the executive branch can create a more hostile, less-profitable environment for traditional energy firms. And it is likely to do so; While similar in rhetoric to the Obama administration on energy and climate change, I think the Clinton administration would be more aggressive, and overall, energy investments look less attractive regardless of the specifics. Low energy prices and increased international concerns about climate change create a “double-whammy”; and should the Democrats control the Senate and the presidency, they can ratify the Paris Climate Treaty and pursue an agenda regarding energy with fairly little political consequence. All of this points towards a less-attractive environment for virtually all forms of oil and coal, and most likely natural gas as well. 

FINANCIAL SERVICES FIRMS ARE LIKELY TO SUFFER AS WELL

Americans of all political orientations and socioeconomic backgrounds seem to harbor an intense hostility towards the financial services sector in the wake of the financial crisis of 2008-2009. Under the Obama administration, the financial sector was treated with some degree of caution in the first two years owing to the dramatic changes brought on by the Dodd-Frank Act and a sense of it’s fragility. In subsequent years, the administration was limited by GOP control of both houses of congress. Despite receiving extensive support from the financial services sector, I don’t expect the history of close financial ties with the Clintons to make much of a difference for publicly-traded financial firms. The presidency - particularly one that shares the same party as the majority in the Senate, with it’s power to approve appointments to various agencies, wields tremendous influence over financial services’ profitability and growth prospects. I would expect the effect to be negative on both, with the exception of investment banks with little or no exposure to consumer finance or products.

MUNICIPAL BONDS ARE LIKELY TO FARE BETTER UNDER A CLINTON ADMINISTRATION

For the same reasons that GOP dominance of the federal government would be bad for the municipal bond market (potentially), Democratic leadership is likely to be a net positive. (For those who didn’t read “What if Trump Wins?”, let me summarize by saying that the health of the municipal bond market is generally more important to Democrats.) Clinton has made a significant chunk of her real estate agenda centers around ‘Mortgage Revenue Bonds’ issued by municipalities to subsidize low to medium income borrowing. To summarize; I think municipal bonds (particularly high yielding ones) are more attractive should Secretary Clinton win.

DEFENSE IS A WILD CARD

Whether we will see an uptick in defense spending is a difficult call. While my general feeling was that a Trump administration was unlikely to be good for publicly-traded defense stocks, Secretary Clinton seems to be willing and interested in projecting American power overseas than her predecessor. It’s no small secret that underinvestment in military hardware, and advances in technology have led to a loss of American leverage in international affairs and this is one of the few areas where there is bipartisan support. While defense contractors have generally faired well over he last few years, valuations remain reasonable. Demand and current trends in naval and aerospace technology would likely benefit Lockheed (LMT), Raytheon (RTN) and General Dynamics (GD), in particular.

IN SUMMARY, ITS PROBABLY ADVISABLE TO REDUCE EXPOSURE TO ENERGY AND FINANCIALS ARE NOT ATTRACTIVE

While the outcome of the election is by no means certain, and I remain reluctant to say with confidence that Secretary Clinton will win, it seems advisable to review clients’ exposure to energy, in particular. It’s a notoriously volatile sector and unlikely to give us much room in the wake of a Democratic ‘landslide’ (defined in this case as a takeover of the Senate and a clear win by Clinton.) Accordingly, I am inclined to liquidate energy stocks and financials in the coming weeks ahead of the election.

As always, please don’t hesitate to call!

Best, Mike

What if Trump Wins?

It would be "yuge"

With the elections in less than a month, investors will face a significant turning point. Both presidential candidates have taken positions and expressed a desire to pursue agendas that will represent a departure from the current administration's.

While not the expected winner by most analysts, if Donald Trump becomes the next president, he will likely usher in several policy changes which will have significant impact on certain sectors of the financial markets. Given the continuing closeness in the polls (and the unreliability evidenced by the “Brexit” referendum) it seems appropriate to review this matter, discuss some potential outcomes and discuss investment strategy in the wake of a Trump victory.

Should Mr. Trump be elected, my assumption would be that the GOP would also retain control of both the House of Representatives and the Senate. It also seems likely that the Republicans will, regardless, expand their majority in the Senate in 2018 due to several state-specific factors. Given this potential scenario, this is likely to embolden the GOP leadership in congress, making it possible that the senate under a “Trump majority” would eliminate the filibuster, making legislative changes and executive appointments far easier. All of this is likely to give President Trump a great deal of flexibility and latitude.

TECH IS SPECIFICALLY VULNERABLE

Most obviously, technology companies would likely experience a significant transition. This has been presaged by the European Union’s regulatory changes in the last few years that have created increased legal and tax liabilities for these firms, but more significantly, the sector currently enjoys an intimate relationship with the Democrats. A change in the party controlling the presidency would leave it vulnerable and less profitable. Should Trump win, the ironic but intense hostility between Trump, his supporters on the “Alt Right” and technology companies over claims of censorship and bias will likely lead to policies that will place pressure on firms like Facebook (FB), Twitter (TWTR), Google (GOOG), Apple (AAPL) and Amazon (AMZN).

Beyond social media, the technology sector overall has been almost exclusively associated with the Democratic party, with more than 85% of donations going to the party and affiliated political action committees.  Since 2012, the relationship has become increasingly poisonous with the Republicans over social and immigration issues. Mr. Trump has expressed specific hostility to Apple's (APPL) offshore manufacturing practices.

The industry has been highly reliant on work visa programs, and offshore accounting and tax strategies which make them particularly vulnerable to tax and trade policy changes that can be initiated from the executive branch. Indeed, many policies could be tailored to specifically disadvantage the technology sector - or even specific firms.

Most notably, Amazon (AMZN) faces risks as Mr. Trump has made it extremely clear that he believes that the company has a "a huge antitrust problem,” and founder and CEO Jeff Bezos’ ownership of the Washington Post seems to largely drive this ‘concern.’ Under a Trump administration, it seems likely the Justice Department will take an immediate and aggressive interest in the firm.

TRADITIONAL ENERGY INVESTMENTS ARE LIKELY TO BE MORE ATTRACTIVE

In contrast, Trump has also made it clear that certain industries would receive much more favorable treatment by his administration. Oil, gas, coal and other traditional energy firms would face an extremely different environment. While unspecific, Mr. Trump has been clear that his energy policies will be a repudiation of the Obama administration’s openly hostile approach to carbon-intensive energy producers. Trump’s specific tax proposals would also make such energy investment significantly more attractive. While the impact of such a favorable approach is less substantial in a world of sub-$50 oil, it’s reasonable to assume that the valuations of various firms in the sector will increase with such changes.

MUNICIPAL BONDS MAY BE LESS ATTRACTIVE

Finally, various municipalities are facing considerable budgetary problems attributable to long underperforming local economies, as well as pension and health care obligations to retired public employees related to demographics. These cities and states are overwhelmingly in Democratic majority regions (but not exclusively so). Depending upon the degree to which President Trump and Republicans in congress sought to inflict blows upon the Democrats (and their tolerance for residual casualties in economically distressed Republican strongholds like Alabama), relatively minor changes in accounting regulations could be devastating to these municipalities and have highly destabilizing effects on the municipal bond markets. The nature of this threat is much less clear, however, than that the threats potentially facing the technology sector.

HOWEVER, THE BEST APPROACH IS TO 'WAIT AND SEE'

At present, it appears that Clinton will win on the 8th. But, I remain less convinced than most of my colleagues - leading me to seriously speculate on the possibility of her losing.

Should polls start to make it obvious that Mr. Trump will likely win between now and the election (a remote possibility, I suspect), then I am inclined to significantly cut back on clients’ exposure to those companies in the technology sector that I've discussed here. However, if the polls continue to show a tight race with Secretary Clinton, then I am inclined to wait until after the election to make adjustments, in particular because I believe the majority of investors will continue to fail to appreciate the significance of a Trump victory in the subsequent market trading days - providing us with an opportunity to adjust accordingly.

Brexit and the Inevitable Panic

As you have likely already read, the United Kingdom voted in a referendum to leave the European Union yesterday. While there are some complicating factors, the turnout and margin were sufficiently large to indicate that there is no going back.

This result was unexpected by most investors and will have significant political, economic and legal implications for both the UK and the EU. Consequently, we are seeing dramatic declines in various stock indices in virtually all markets - including the US. 

While I expect that our portfolios will experience some decline in value as a result of this development, I expect the impact to be relatively limited and short-term in duration. Our clients generally have considerably less exposure to the foreign stocks than the “average” diversified, professionally-managed investor. And, the process of the UK’s withdrawal from the EU will be a long and complex one. 

Accordingly, this development does not justify any changes in investment strategy at this point.

However, markets trade on anticipation and exaggerate the significance of such developments. As I’ve argued throughout this year, I expect to see volatility in 2016, and the next few days are unlikely to disappoint. 

I’m reminded of the old J.P. Morgan axiom that the best time to buy is when “there’s blood in the streets.” If we do see significant sell offs, this would likely justify most clients increasing their exposure to equites overall, and UK stocks in particular. 

In short, I don’t recommend making any significant moves, other than to see this as possibly a buying opportunity for UK and European stocks in relatively small amounts in the coming days and weeks.

Puerto Rico, Apple and Goldman Sachs

The markets have firmed up quite a bit in the last couple of months, but we’re likely to be in for a rocky summer.  Summer has a tendency to be volatile. Earnings reports are mixed and diverse - Apple is clearly entered a soft patch, but Facebook is charging forward and beating estimates.("Sell in May and go away.")

Companies overall are maintaining spending at relatively modest levels,  while consumers are belt-tightening. We’ve seen some increases in the individual savings rate, suggesting that behavior is shifting towards more conservatism. Data says they’re optimistic about their prospects, but are very concerned about the future. (This is usually a good predictor for the markets, ironically.)

Probably the most attention grabbing issue is Puerto Rico, which will be upping the ante in a new phase of its bankruptcy with a negotiated default on a 'Puerto Rico Government Development Bank' bond that came due on the 2nd. This was predictable but one thing is clear - the matter is far from resolved.

What’s significant about this recent change is that it now unquestionably places the territorial government in “default." This particular defaulted GDB bond was a little different in that it’s specific holders were a fairly concentrated group. It looks like the pool of hedge funds / mutual fund investors will get something between $0.45 and $0.55 on the $1 for the face value of the bonds (plus all of the high interest they collected over the last few years.)  

The Puerto Rican government (PR) seem to be genuinely committed to avoid a default on the General Obligation (GO) debt. A default would be unprecedented, and PR’s pretty much stated policy at this point is to try to heavily bail out the GO bondholders -- by imposing much worse terms on the non-GO debtholders (the electric utility, the Development Bank, highway bonds, etc) in the hopes of continuing their future access to the bond market.

Nobody has confidence in the locals’ solution, and everyone is waiting for congress, or the Supreme Court, to act, so we have paralysis. We should expect more defaults, and more rhetoric in the coming months.

What this means, is that (barring some miracle), the process of resolution will likely head well into next year and we still don’t know what ‘resolution’ will look like. Investors need to be patient and let the process work itself out. Everyone agrees that Puerto Rico needs access to a bankruptcy process, and there is now pretty much consensus from the mainland institutions that a Financial Control Board needs to be put in place. At issue is how powerful the board would be and over several labor and tax / entitlement reforms. We’re still working things out I remain confident that the matter will be eventually be resolved, but not fully until next year. 

Much more interesting and indicative of the current economic environment was Apple’s disappointing revenue growth over the last year (worst in 13 years.) It’s certainly gotten a lot of investors worried that Apple has ‘lost its mojo.’ 

Largely unnoticed was that Apple is increasing its dividend considerably (9%) and buying back more shares. At its current dividend, strong financials; I think it’s hard not to make the case that the company is both an attractive, stable company with both near term and long term prospects. Its main problem is that it’s too big in terms of market capitalization, and its non-dividend growth shouldn’t be expected to be too high in the future. I see Apple is a “value stock” and an "income play."

But it’s true, the problem with Apple isn’t confined to its sheer size. The last few products the company put out were disappointing. But the company has a long history of innovation, and seems to have the best minds in the industry. (And, even without high growth in the future, it’s income yield is equivalent to US treasuries.)

Finally, on a more pleasant note - it’s interesting that Goldman Sachs has chosen to enter the online banking world and start collecting retail deposits. This might be a great way to leverage their brand. They’ve recently announced some very attractive cash management products. (1% on money market; Apparently their status as a bank holding company really encourages them to try and bulk up on deposits.) 

We’ll see if they’re serious about gathering retail deposits in the coming year, but the high interest they’re offering is an extremely encouraging sign and a reason to look both placing cash positions there and to look at the stock.