Plans by new US President Donald Trump to cut taxes and regulations may outweigh the costs of tariffs and be net positive for US equities, say Boston Partners’ portfolio managers.
The populist new president has promised to cut the US’s notoriously high corporate tax rates along with personal taxation, and then repeal regulations affecting Wall Street and the energy industry. But has also threatened border taxes on imports in a protectionist ‘Buy American, Hire American’ campaign to create more jobs that would hurt US companies with overseas facilities or suppliers.
“The US still has the highest corporate tax rates in the world and they need to come down,” says Josh Jones, co-portfolio manager of the Boston Partners Global Premium Equities fund. “If companies are growing and hiring people, the tax base in the US will go up, and that’s a good thing. Companies can then focus on where they’re productive and hire people, rather than thinking about where they need to go to lower their tax bill.”
“So that would be a big positive. The populist thing has occurred because people are tired of losing their jobs; it’s happening everywhere, so protectionism is not good for corporate profitability or economic growth, but the world goes through these cycles. But it’s hard to know with Trump; there will be a lot of unpredictability, and obsessing over whether it will go through or not is not the right way to approach it. The right way is to understand the implications for the businesses that we own.”
“For example, say we have two stocks trading at 15 times earnings, and we think both have similar upside from a fair value perspective. But we realize that one of them would be negatively impacted by Trump and the other one wouldn’t – then the obvious thing to do would be to move more capital into the one that wouldn’t be impacted. So we want to minimize the risks of something going through, positive or negative, without sacrificing the characteristics of the portfolio.”
Regulatory cuts would also be a big positive, says the fund’s lead manager Chris Hart. “As of now the expectations are that Trump will firstly want to cut corporate taxes, secondly cut personal taxes, and thirdly, and probably most importantly, significantly curb regulations that were put onto industries by the Obama administration,” he says.
“Those levels of regulations have probably been a very strong impediment to allowing a fair amount of the multiplier effect from the Federal Reserve to flow through the economy. Right now there is really no sign of a recession occurring. Lower taxes and lower regulation should be a boost to economic growth; it is very difficult to put a number on it, but they are net positives.”
Tariffs are not usually good for corporate profitability
The biggest potential negative – particularly for the emerging markets in which the fund includes in its universe – are the threatened tariffs, Jones says. “We don’t really know what will happen with the legislation around the border tax adjustments, but there could be a pretty profound impact on corporate profitability if something does go through,” he warns.
“Tariffs are not usually good for corporate profitability, whereas outsourcing through globalization has been good for earnings, and a reversal of that should be expected to be negative. However, it’s unclear whether Trump is using the threat of tariffs as a negotiating tactic to keep companies’ facilities in the US rather than moving production abroad. So we’re being very cautious in understanding our portfolio exposures, as we don’t know whether this will go through.”
In the US, the fund’s two most favored sectors are the ones that would benefit most from regulatory changes. “We’re overweight US banks and energy,” Jones says. “Currently, the larger US banks are not nearly as cheap as they once were, though they’re still reasonably priced with some earnings growth potential, and they’re returning capital to shareholders, so we’ll continue to hold onto our overweight until we find something better.”
“We like some of our US energy holdings more than other energy companies elsewhere in the world. We have found opportunities mainly in small and medium capitalization exploration and production companies like Diamondback Energy and Parsley Energy operating in the Permian Basin. These are very well run businesses with low cost asset bases and good acreage.”
Jones says emerging markets have become riskier, led by the ‘elephant in the room’ – China. “If Trump does put through the border tax adjustments, then this would be very negative for emerging markets,” he says. “Our main concern is that China is in a very big credit cycle. If you put China’s money supply growth, credit expansion and bad debt on a par with other big banking crises, then it’s monstrous. It’s bigger than the US sub-prime crisis was; it’s really that bad.”
“If they want to keep lending and growing their money supply and back-filling all this bad debt, then they may have to start a more aggressive quantitative easing program, which would probably devalue their currency. So that could be a real problem for emerging markets, and the wider market which is now currently focused on the reflation trade.”
In Europe, the surprising sweet spot has so far been the UK following the Brexit vote to leave the EU, Jones says. “The main opportunity that could come to fruition over the next six to nine months, from a bottom-up perspective, is in the UK,” he says. “That is purely driven by valuation support and the overreaction to the Brexit. The valuation support for many domestically orientated UK names, combined with stable-to-improving fundamentals, offers opportunities.”
However, continental Europe faces a difficult year, with elections in the Netherlands, France and Germany that may see a resurgence of the populist movement that ushered in the Brexit and Trump. “For the EU, the bigger threat is Italy or Spain leaving the bloc,” he says. “A nationalist movement in the US that results in protectionism is not great, but it’s manageable; a nationalist movement in the EU that rips apart the EU is a really big deal.”
“This has been priced into the UK but not in Europe. Increasingly the opportunity looks like you want to be overweight in the UK and underweight continental Europe. But then I’m more excited about our opportunities in Europe going forward than I am about our opportunities in the US, where we’re not finding as many good ideas.”
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