With the recent Senate decision not to implement even a so-called skinny repeal of Obamacare, the Trump administration is at crossroads. President Donald Trump, and some of his senior advisers, would still like to pursue a repeal of the existing health-care structure. Several senators and congressmen would, instead, prefer to focus on corporate and personal tax cuts in an effort to boost growth.
Although reforming health care and achieving annual gross domestic product growth of 3 percent or more were both important Trump campaign promises, which objective the administration pursues first would have major implications for investors. Specifically, emphasis on health care as the top priority would lead to disappointment for equity investors. Financial market participants were hoping to benefit from dismantling onerous regulations, cutting corporate taxes and introducing plans for infrastructure spending. Realistically, the U.S. Congress can’t handle both major issues at the same time.
With sharply divergent views even among Republicans on issues ranging from covering patients with pre-existing conditions to maintaining payments to insurers to subsidize low-income participants, no quick resolution to the health care debate is likely. Top officials such as Treasury Secretary Steven Mnuchin also have to persuade Congress to increase the federal debt limit — Bloomberg Intelligence estimates that the U.S. government will run out of money as soon as Oct. 3. A default on Treasury debt, or a government shutdown, would be among the consequences of not passing a debt bill on time.
Such competing pressures mean that if health care does stay on the congressional agenda, tax reform and deregulation may not happen before 2018, at the earliest. In addition, failure of the much ballyhooed health-care effort has led to recriminations among Republican members of the Senate, and deteriorating relations between the Senate and Trump. If Trump and the Senate try yet again to repeal Obamacare and fail, investor confidence in a subsequent passage of market-friendly reforms is likely to take another hit, with unfavorable implications for the equity market.
Equities don’t reflect such investor concerns yet. A healthy increase in U.S. corporate profits through the second quarter helped push markets to new records, leading some analysts to suggest that any policy impasse in Washington is of little consequence for financial markets. Some even say that government inaction would be a positive development since it would mean less interference in the market mechanism.
There are no grounds for such complacency. Expectation of fewer restrictions on banks’ activities was important in explaining the rise in financial-industry valuations so far this year. Trump’s statement that he would spend as much as $1 trillion on infrastructure projects caused shares of companies such as Caterpillar Inc. and Aecom to jump as soon as the election results were known in November. Shares of both companies remain well above where they were before the election. Lack of action on these fronts would signal that equity markets need a correction from their overvalued levels. For example, the Standard & Poor’s 500 Index is trading at an elevated 21 times the past 12-month per-share earnings, and at more than 30 times earnings, according Yale professor Robert Shiller’s cyclically adjusted P/E (CAPE) measure.
Simply put, corporate earnings need the tailwind of favorable tax and regulatory policies if they are to continue rising. For example, the 15 percent corporate tax rate favored by Trump compared with the current top rate of 35 percent, if enacted, would go a long way toward encouraging U.S. corporations to repatriate a large share of the more than $2 trillion that they hold abroad to avoid the high U.S. taxation. Some of the funds would be used to pay higher dividends to shareholders, but a major portion is likely to be employed to expand production and hire workers.
What are investors’ options? Stocks would continue to be attractive if they get support from long-promised Trump stimulus measures. On the other hand, if policy discussions remain focused on health care, investors may decide to reduce risk in their equity exposure, find that gold shines even brighter than it has in recent weeks, and look for safety in U.S. Treasuries.
Komal Sri-Kumar is the president and founder of Sri-Kumar Global Strategies, and the former chief global strategist of Trust Company of the West.