Super Tuesday special: How President Trump could spark a market blow-off

In Free by Cam Hui

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Let me preface my remarks with two caveats. Firstly, I am politically agnostic and I don`t have a horse in the latest race for the American presidency. As a Canadian, I can`t vote in a US election. As well, it might be considered foolhardy to project what a politician might do based on his campaign promises, particularly during primary season.

Nevertheless, as Donald Trump has strengthened in the Republican primaries and he has become a serious contender, it is time to consider what a Trump Administration might do (much in the spirit of my last post How to trade the Brexit referendum).

Trumponomics revealed

There are some clues on what a President Trump might do. CNN recently asked, So what exactly is Donald Trump’s economic policy? These are summarized below, with likely equity market effects:

  1. Massive tariffs on China and Mexico: Bearish, the former would kill the global supply chain and the latter would be difficult without abrogating NAFTA.
  2. Keep the minimum wage, but not increase it: Neutral, as it represents the status quo.
  3. For a wealth tax, but also big tax cuts: Bullish, see analysis below.
  4. Get Wall Street pros to run the economy: Bullish, at least in the short-term.
  5. Repeal Obamacare: Uncertain as details are unavailable.

I would add that not detailed is the CNN article is the stated desire to leave Social Security and Medicare unscathed. The WSJ also featured a recent article on the Trump tax plan, which detailed the massive tax cuts that he has proposed:

Republican presidential candidate Donald Trump unveiled an ambitious tax plan Monday that he says would eliminate income taxes for millions of households, lower the tax rate on all businesses to 15% and change tax treatment of companies’ overseas earnings.

Under the Trump plan, no federal income tax would be levied against individuals earning less than $25,000 and married couples earning less than $50,000. The Trump campaign estimates that would reduce taxes to zero for 31 million households that currently pay at least some income tax. The highest individual income-tax rate would be 25%, compared with the current 39.6% rate.

Many middle-income households would have a lower tax rate under Mr. Trump’s proposal, but because high-income households generally pay income tax at much higher rates, his proposed across-the-board rate cut could have a positive impact on them, too. For example, an analysis of Jeb Bush’s plan—taxing individuals’ incomes at no more than 28%—by the business-backed Tax Foundation found that the biggest percentage winners in after-tax income would be the top 1% of earners.

Mr. Trump’s plan appears designed to help him, as the GOP front-runner, cement his standing as a populist—though that message is complicated by the fact that the billionaire, like other Republican leaders, would eliminate the estate tax.

Trump would offset those tax revenue losses with the following revenue offsets:

To pay for the proposed tax benefits, the Trump plan would eliminate or reduce deductions and loopholes to high-income taxpayers, and would curb some deductions and other breaks for middle-class taxpayers by capping the level of individual deductions, a politically dicey proposition. Mr. Trump also would end the “carried interest” tax break, which allows many investment-fund managers to pay lower taxes on much of their compensation.

A significant revenue gain would come from a one-time tax on overseas profits that could encourage U.S. multinational corporations to return an estimated $2.1 trillion in cash now sitting offshore, largely to avoid U.S. taxes. His proposal would impose a mandatory 10% tax on all of that money, even if the money stays overseas, but allow a few years for the tax to be paid. The Trump campaign estimates that many companies would choose to bring their money back home, boosting jobs and investment in the U.S.

Mr. Trump also would impose an immediate tax on overseas earnings of American corporations; currently, such tax payments can be deferred. All told, the campaign says the plan would be revenue neutral—neither raising nor lowering federal revenues—by the third year and then begin adding revenue.

To summarize, the key points of the Trump tax plan are:

  • Massive income tax cuts
  • A flatter tax structure
  • One-time tax break for corporate repatriation of overseas profits

Trump 2017 = China 2009?

These measures are represent a shock-and-awe fiscal Keynesian stimulus of the American economy. Trump differs from FDR-style Keynesian stimulus as his plan does not involve direct government spending, but tax cuts. The net effect remains the same. Taken together, it is reminiscent of China’s shock-and-awe stimulus spending package in the wake of the Great Financial Crisis.

The Trump plan would also blow an enormous hole in the budget deficit and debt outlook. The Fiscal Times summarized the fiscal effects of the Trump plan this way:

The nonpartisan Tax Policy Center has pegged the 10-year cost of Trump’s proposed tax cuts at $9.5 trillion — or $11.2 trillion if you add in interest on the debt that the tax cuts will generate. The nonpartisan Tax Foundation says that Trump’s tax plan would cost the Treasury revenues of $10 trillion over the same period, but they reached that conclusion by giving Trump credit for economic growth. Either way, Trump’s approach would send deficits and the long term accumulated debt through the roof.

Likely market reaction

Rather than recoil in horror at the spike in debt, let’s consider the likely market effects should such a plan get put into action:

  • Income tax cuts: Bullish for consumer spending and the economy.
  • Overseas corporate cash repatriation: Bullish for capital spending.
  • Deteriorating national debt outlook: Bearish for USD, but bullish for commodities and US exporters which have faced earnings headwinds from a strong exchange rate.
  • Rising tariffs: Bearish for stocks, but it depends on implementation.
When I put it all together, the Trump plan would be very equity friendly for the first couple of years, until the Fed puts the brakes on inflation by taking away the punch bowl. No doubt it will all end badly in a recession, but The Donald will throw America a huge party first.
Equity bulls should rejoice at such a prospect. They can turn bearish later.

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