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The new US president has pledged to overhaul US trade relationships, to deliver a better deal for the US economy and workers. We talked to Steve Barry for the Fundamental Equity team’s take on the implications for corporate America and equity investors.
Trade policy and tax reform are of paramount importance for our teams this year, as we see a broad range of possible outcomes that could shift the competitive landscape. We think aggregate US equity valuations are elevated and the combination of heightened policy uncertainty and Trump’s provocative leadership style could cause volatility to trend higher. As policy details materialize and investors digest the company-specific implications, we expect to see increased differentiation across sectors and individual stocks.
In other words, financial markets are likely to be bumpy, but the resulting dispersion of returns should create a target-rich environment for stockpickers and active managers in general.
We are particularly focused on the potential for the administration to impact global trade channels via the tax code, specifically with some form of border-adjustment tax. Companies have evolved their supply chains over decades to maximize profits based on the existing rules. But those rules are changing. Companies may soon face major decisions on issues such as whether to bring industrial production back to the US and repatriate profits, even as they adjust to other significant tax and regulatory changes. This process of adapting to a new competitive landscape could be a shakeup for corporate balance sheets, with implications for profits.
We see a combination of possible actions, however. The president has a variety of tools at his disposal and some scope for unilateral action via executive orders. We’ve already seen his signature on the intention to withdraw from the Trans-Pacific Partnership, we take him at his word that a renegotiation of NAFTA is on the table and we see potential for an escalation of tariffs. We are also prepared for a new source of idiosyncratic risk arising from President Trump’s use of Twitter as an unmediated forum to publicly applaud or apply pressure on companies with respect to their business decisions. We see more potential for “tweet risk” to drive sudden market moves, and pharmaceuticals and autos are among sectors we consider potentially vulnerable, as competitive drug pricing and job losses to offshore production have been recurring themes for the president.
There will be a lot of noise as the Trump Administration gets established and much is still to be determined. However, Trump is unconventional, not unpredictable. He has been outspoken and consistent in his views on trade, and we think his “America First” platform is unequivocally pro-US manufacturing, employment and domestic growth. So we are mindful of the overall policy direction—to level the playing field, in line with the administration’s view that the US is currently at a competitive disadvantage.
We are also putting significant resources into analyzing more specific policy scenarios with the goal of identifying those companies with the best prospects for growth under a variety of conditions. Among the key variables are their reliance on global supply chains (see chart), how much of their production is offshore and their broader exposure to potential increases in import costs or, on the positive side, additional credits for exports. We also consider these variables in light of potential currency fluctuations.
Source: Dept of Commerce and Goldman Sachs Global Investment Research, as of December 2016
Broadly speaking, we think companies that ‘manufacture where they sell’—that is, their production is local to their customer base—stand to gain, as do export-focused sectors such as aircraft manufacturers. Companies with relatively high tax burdens under the existing rules may get relief, particularly those that might qualify to repatriate offshore profits at a lower rate. We see potential downside for industries heavily reliant on imports such as apparel and the broader retail sector, and companies that have benefitted from relatively low tax rates under the existing rules.
But these are still broad brushstrokes, and only a part of the opportunity set. The implications of revisions to US trade relationships are likely to be disperse, across both developed and developing markets, and the global reach of this investment theme suits our global scope as managers.
