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March 2017 | Macro Insights

Roundtable: Un-Making the Rules

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In his first six weeks of office, President Trump has signed 15 executive orders. Six relate to regulatory rollback, including one requiring that for each new rule, two should be scrapped. In a divided political environment, the prospect of a simpler regulatory regime has broad appeal. We asked our investment experts about the implications across US corporate sectors and financial markets.

As of March, almost 100 Obama-era regulations have been stalled or revoked. Which sectors are most affected and how?

Arege: The healthcare, financials and energy sectors have been at the center of regulatory action over recent years, and so are primary targets for the new administration’s pledge to repeal and loosen rules. The impact of the proposed healthcare reforms is still unclear and likely to vary across sectors, but less regulation is widely perceived as business friendly and has contributed to stock market gains. Sectors such as industrials can also benefit from greater capital efficiency if compliance costs come down, and investment decisions should be easier both for US companies and for global investors looking to allocate incremental dollars.

Last month we discussed potential pro-growth aspects of President Trump’s policy agenda. How could regulatory loosening have an impact?

Golder: Regulatory relief could be an added growth impulse for a healthy economy that was already making strides towards full employment. With the added stimulus of fiscal expansion, we would expect the recent improvements in industrial surveys to translate to hard data. In particular, we see room for increased capital expenditure in a more confident business environment, given the patchy recovery since the crisis. As a result, we have positioned portfolios to gain from continued credit expansion and modest defaults, while preserving liquidity to make adjustments under stressed scenarios.

Arege: A lot will depend on the time horizon, as the full impact on GDP probably won’t be tangible this year. In the short term, the expectation of less regulation is helping to build confidence in corporate America. But over a one- to three-year horizon the boost to growth could be meaningful, in combination with tax reform and infrastructure spending. We are watching manufacturing and loans data for the follow-through. Manufacturing has been strong, with the purchasing manager’s index (PMI) pointing to expansion consistent with annualized economic growth around 2.5%. Loan growth has slowed, but the pace is still healthy and the series is volatile.

Why do you think the GDP impact from the regulatory unwind may take longer than some expect?

Golder: The timeline for sector or company impacts can vary significantly, which is why assessing regulatory events is part of our fundamental research. Some of the regulatory unwind on the administration’s agenda may take longer than anticipated, depending on how they rank among priorities that include tax reform and infrastructure spending, and what measure of Congressional support they will require. 

Loupis: We would look for the full GDP benefit in 2018 and beyond. While greater clarity on regulations should facilitate decision-making and approvals for large-scale projects, the interval to operations and revenue generation can be lengthy. We expect to see follow-through in energy infrastructure investment, but material production growth may not come for several months after a project is undertaken, even in short-cycle projects like shale.

If improved sentiment boosts investment, would you expect more M&A and what would the implications for credit be?

Waxman: If CEO confidence continues to improve, we could see some uplift in strategic M&A in the medium- to longer term. Management teams may start to focus more on investment, as well as revenue and market development opportunities, as a justification for doing deals. But certainty is as important as confidence for M&A, as volatility is a deterrent, so clarity on regulations and tax policy will be key. That said, the Obama Administration presided over an M&A boom, and President Trump’s stated emphasis on jobs may mean more obstacles to consolidation in some sectors.

Golder: M&A and other event risks continue to influence our positioning, particularly within the telecom and cable industry, which could see more dispersion of performance.

Our high yield team sees opportunities in Communications. Some cable, cellular and satellite companies may stand to benefit if regulatory shifts allow for increased consolidation, in addition to the tailwinds of increased mobile data usage for activities such as ecommerce and entertainment. 

Do you think the regulatory outlook is already priced into markets, and are there sectors that you think are over/understating the impact?

Arege: I don’t think the longer-term implications are discounted in stocks. The initial expectation of a less-burdensome regime, combined with tax cuts, has driven US indexes to new highs on sentiment. However, we expect greater differentiation among individual stocks over time, as the policies will likely impact companies in a variety of ways. Stock and sector correlations have fallen significantly in the last six months, and we think this trend plays to the strengths of active managers. We see opportunities in Financials, as the sector is trading at a discount to long-term averages on some metrics relative to other sectors, where valuations already reflect positive sentiment.

President Trump’s rhetoric and executive orders favor natural resources. What is your outlook for the energy sector?

Loupis: We favor midstream companies such as pipelines as they are federally regulated—upstream companies are regulated at the state level—and they are less exposed to fluctuations in commodity prices. And energy infrastructure funds have already registered strong inflows year-to-date.

Waxman: We think pipelines should benefit as increased production leads to improved cash flows. Many companies made good use of the recent oil price crash, cutting unit-holder distributions and raising equity in order to keep their investment grade ratings. The new administration could make it easier for companies to grow organically via capital projects, which could alleviate pressures to use acquisitions to drive growth. For oil and gas producers, price stability should help support balance sheets, though we are watching supply-demand dynamics and how companies are deploying cash flows. A shift back toward capital spending and production growth—possibly enabled by reduced restrictions on drilling—may be positive for pipelines, but could depress prices if demand does not keep up.

What are the risks to your outlook for the oil and gas sector?

Loupis: The change in regulatory stance is a strong positive but it’s only one piece of the puzzle for the oil sector. What matters beyond policy is prices and the cycle. Oil companies might have more federal land to drill but they won’t unless the numbers add up. And regulations can ignite activity but the cycle needs to work in the industry’s favor as well. We think the two are well aligned now from a timing perspective, as the market has moved out of oversupply. 

Do you see setbacks for renewable energy?

Waxman: We think the rise of renewable energy is inevitable. Technological advances and efficiencies are driving down the cost of clean power, and while this trend may slow if government subsidies are canceled or not renewed, market forces are in place to sustain it. Moreover, clean power is a jobs-rich industry for a president focused on getting more Americans to work, as solar employs more workers in electricity generation than the oil, coal and gas sectors combined.

We don’t think federal policies can stop coal’s decline, though they could slow the pace. Today natural gas is a cheaper energy source and even if utilities received a tax credit to build new coal generation facilities, they will look beyond this administration to justify long-term investment. We will consider investments in utilities with a substantial coal footprint, but we want to be compensated for the risk. Moreover, we’ll want to see how the longer-term plans of coal-intensive utilities align with state regulations. Already 29 of 50 states have adopted mandatory renewable portfolio standards, while another eight have voluntary targets, and many are now taking steps to increase their commitments. 

You say the implications for the healthcare sector are mixed. How is your positioning guided by the policy outlook?

Waxman: The GOP’s replacement of the Affordable Healthcare Act is under debate so we’re watching developments closely but it’s not affecting our positioning. We see challenges across the sector, but opportunities among names that have cheapened on regulatory and other concerns, or issuers that had added leverage for M&A and are now seeking to improve their balance sheets.

We are underweight Pharmaceuticals, in part because pricing is likely to come under increased scrutiny and, if not legally controlled, may be affected by moral suasion. We are negative on issuers most reliant on large price increases to drive growth. That said, our sector view is mainly due to unattractive valuations, the risk of M&A and the potential for a tax break allowing repatriation of overseas earnings, which could be used to benefit shareholders. 

About the Authors

John Arege

John Arege

Co-Lead Portfolio Manager of Large Cap Value & Large Cap Core Strategies
Kyri Loupis

Kyri Loupis

Lead Portfolio Manager, Head of Energy & Infrastructure, Goldman Sachs Asset Management
Stephen Waxman

Stephen Waxman

Head of Global Investment Grade Credit Research

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