We need to consider how America’s next president may influence the the outlook for our investments. – Straight Talking
Welcome again to our regular Straight Talking column – written by senior financial planner at ipac WA, Bob Miller
We need to consider how America’s next president may influence the outlook for our investments. Donald Trump’s personal qualities are unlikely to affect our investments, but his policies will.
History tells us that it can be unwise to pre-judge presidents. Ronald Reagan was initially misjudged by many people, including the writer. Some readers will remember Ronald Reagan’s presentation of the America’s Cup to Australian connections in 1983. It was a class act from an ex-actor with easy charm. But class alone should not define a president. Reagan’s actions, however, defined his presidency. By applying immense pressure to what he called the “evil empire”, President Reagan mad a significant contribution to the collapse of the Soviet Union…. and the subsequent end of the cold war. This, in addition to policies which helped to usher in a period of economic prosperity, ensured that Reagan earned his stripes as an outstanding President.
Let’s focus what Donald Trump might do, rather that what he said during the campaign. (Does anyone really believe that Trump will build a wall and send the invoice to Mexico?)
For investors the worst thing Trump could do is tear down trade treaties (and reduce related economic activity between the US and the rest of the world.) Hopefully, the President-elect’s tough talk is merely a ruse to secure better trade terms.
Share and property investors require economic growth to maintain an optimistic outlook. Such investors are comforted by additional demand. In the absence of an equivalent increase in supply, the price of any good or service must rise, serving to enhance profits. In such an environment, we can expect additional investment in productivity – enhancing plant and equipment … and spillover benefits for the entire economy.
Donald Trump has appalled many because of what he said. But what if his plans to make America “great again” really work? What if he was responsible for fundamental change in America’s tax system, which in turn led to a massive increase in business on American soil? The tax story has two parts. Lets look at each.
Currently US businesses pay a tax of 35 per cent on profits and, if they have offshore operations, on global profits. Trump proposes to dramatically lower this rate. His opening position was 15 per cent tax, but Congress is unlikely to pass such a radical proposal. A significant reduction, can be expected. This would have two striking economic effects. First, it would immediately produce a surge in profits and then job-creating investment. Second, it would blow an early hole in the federal budget, as tax revenue is slashed. In the medium to longer term, tax revenue should rise, as additional employment generated both additional income and tax revenue … as well as further business tax from news and expanded operations.
Changing the tax treatment of global profits could produce a drastic increase in US jobs, with no budget downside whatsoever. Since this proposal looks like a free kick for the US economy, we need to examine it.
The scheme, put forward by Alan Auerbach in 2010, hinges on applying tax on cash flow, rather than profits. Accountants tell us that taxing profits is hardly straightforward, relying on depreciation schedules among other things.
Taxing cash flows and excluding all foreign transactions makes things a lot simpler. Furthermore, applying the cash flows only to domestic transactions would remove a tax incentive for American businesses to operate elsewhere, including low-tax offshore operations.
Clearly a cash flow tax system has potential to revolutionise both US job opportunities and US tax revenues. Under such a system, the US budget deficit must fall, while the debt situation must improve.
Given that a significant number of Republicans will soon control both the House of Representatives and the Senate, it’s hardly a stretch to envisage Donald Trump will ensure the proposal becomes law before too long. It appears to fit in with his desire to see a surge in US manufacturing jobs, as part of his promise to making America great again.
At the very least, a substantial lowering of the US business tax would enhance business profits and lead to expansion of investment and a sizeable increase in the workforce. All this should add to wage pressures. And given an increase in wages is a significant factor in raising the purchasing power of the lower paid in the United States, it’s clear that US business should eventually become stronger following an increase in wages for the lower paid.
Trump’s win is not good news for bond investors, who are always better off when interest rates fall, automatically increasing the value of existing bonds. But Trump’s proposal to spend a vast amount of money on infrastructure projects in an economy already growing nicely is likely to be inflationary, fuelling interest rate rises and falls in the value of existing bonds.
Provided President Trump does not trash trade treaties, it’s hard to imagine the US economy not growing quite strongly. A stronger US economy is invariably beneficial for the rest of the world, especially investors in shares and property. The West was grateful for Ronald Reagan in the 1980’s. Perhaps one day investors will look back in gratitude at Donald Trump’s presidency!
If you would like to discuss anything that you read here, feel free to contact an ipac WA financial planner today to meet with us in our Perth offices and see how change can impact you.