January 25, 2017

Stocks moved higher as investors reacted to the rapidity of new actions from the Trump administration.  Both the NASDAQ and S&P 500 set new all-time highs.

In his first two days in office, President Trump has held several meetings with corporate leaders repeating his goals of less regulation, tax reform and revised rules of the road for trade that could include both taxes and incentives to increase jobs in the U.S. and return some manufacturing to our shores.  The actual trigger for yesterday’s rally was a separate announcement of Executive Actions to restart negotiations to build two key pipeline projects that the Obama Administration rejected.

As always with Trump, it is important to get past the original optics that are often expressed in loud, stark and combative terms, and go quickly to the fine print.  The two pipeline actions are cases in point.  President Trump didn’t approve either project.  Rather he set in motion a rapid review process that could lead to one or both being completed.  Any student of Trump’s past will know that review and renegotiation also gets back to costs and other economic factors.  We should also note that any approval still has to follow a legal roadmap which could ultimately include court challenges.  While I would put the odds of both pipelines getting built as high, the legal process will still work to slow things down.  As we have seen in just two days however, Trump isn’t going to be patient and will press to move his agenda forward.  That is exactly what the investment community wants to see and why stocks pushed higher in the aftermath of yesterday’s announcement.

A lot has been made of the President’s push to try and keep manufacturing in this country and to return offshore manufacturing home if practical.  Despite the tweets and harsh sound bites, the Trump team understands that no one expects products like televisions or shoes to suddenly come back home.  He also understands that if we put taxes or tariffs on imports, our trading partners will react in obvious ways to stifle the export of American products.  While Trump is accused at times of not being very detail conscious, he has a team around him that will be very detail oriented.  Trump’s behavior is always to stake out an initial position and then move back toward the center.  His message of the past three weeks is clear.  He doesn’t want to see General Motors or any other car company or, for that matter, any major manufacturer, build a plant in Mexico, for instance, that will ship most of its production back into the U.S.  He is not saying that GM can’t build a plant in China to sell cars in China.

With that said, corporations must act rationally and in their own self-interest.  One of Trump’s major campaign foundations was his opinion that the U.S. has allowed itself to be disadvantaged by its major trade deals and he wants to negotiate them all.  He has already backed away from the TPP, which was probably dead anyway, and wants to review and revise NAFTA as soon as possible.  Corporations need to know the rules of the road before committing capital for large projects.  If Trump renegotiates NAFTA to provide substantially less incentive to build in Mexico to ship to the U.S., then corporations will react accordingly.  They are not altruistic entities; they understand the bottom line.  Few are going to make major decisions regarding Mexico until they see how NAFTA is revised.  Trump understands this.  He most likely won’t force action before NAFTA is renegotiated but will be quick to push to move jobs back to the U.S. if he can renegotiate NAFTA on terms more favorable to the U.S.  He views the restructuring of NAFTA as the way for Mexico to pay for his wall.  Today, there will be another order signed to reallocate money to start building the wall.  This is more about his messaging to Mexico than it is an actual start of a huge wall across the entire border, something that almost certainly will never happen.

Trump is unique.  No one can argue that point.  It will take us all a while to adjust and understand what’s going on.  Part of what’s going on is going to be abrasive and unsettling.  But it is important as investors that we don’t get lost in the noise and lose focus on the economics.  I don’t expect massive (his words) movement in economic growth as a result of anything I just said.  Moving a few big plants and building a couple of large pipeline projects are symbolically important but, by themselves, won’t move the economic needle.  But collectively steps taken and to be taken will add up and move the needle incrementally.  These steps will raise growth, increase American jobs, lift inflation and push bond prices lower and interest rates up.

Most would add that these steps will increase the value of the dollar as well.  I am less sure of that conclusion.  The currency market serves as a balancing mechanism to even out trade flows.  Weaker nations’ currency values decline to give them a trade advantage.  Strong nations see currency values rise.  If the U.S. is to grow faster, it would be logical that the value of the dollar would rise.  But that pre-supposes that we grow faster in a vacuum.  If we start to accelerate, would it be wrong to expect Europe to begin to wind down its easy money policy and see bond yields turn positive once again?  Japan is beginning to react to past monetary easing steps and seeing its own acceleration of growth with a touch of much wanted inflation.  Thus, as stock prices and interest rates here have moved generally higher in recent weeks, the dollar has retreated almost 4%.  I am not insinuating that the dollar is about to weaken, but I am saying that it isn’t a slam dunk that rising U.S. growth means a higher dollar.

Part of the administration’s tax reform package is predicated on some form of border tax.  Discussions are still in an early stage.  Proponents of such a tax, which undoubtedly would raise prices of imported goods, suggest that a strong dollar would offset the effects of a higher tax.  That may be so, but if a tax slows trade and has a negative effect on growth, the offset could be very modest.  One should remember that Trump’s base is Middle Class America.  Many don’t pay a lot of income tax.  Cutting the top rate to 15-20% won’t impact them, but a big border tax that forces the price of imported products higher would hurt.  How all this plays out is an unwritten story; so far we have only seen the outline.  Whatever happens, we are entering uncharted waters and some adjustments are likely along the way.

Today Alicia Keys is 36.

James M. Meyer, CFA 610-260-2220

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