The outlook for more fiscal spending has received significant attention, but the potential for de-regulation may have a bigger impact on growth and markets in 2017. In the US, Trump’s proposed regulatory changes are focused on improving access to capital and reducing barriers to business formation. In Europe, corporate support for a Brexit outcome was driven by concerns about excessive regulation, and European financial institutions have begun to push back against the wave of post-crisis regulation. Meanwhile, China continues to seek the right mix of regulation and stimulus to drive structural reform while maintaining economic growth. As a result, we will be watching the degree of regulatory divergence across the global economy and the potential for competitive de-regulation.
Regulation Among the Top Concerns of US Small Businesses
Source: Bloomberg, National Federation of Independent Business. As of November 2016.
Divergence in Financial Sector Regulation
Appointments at agencies such as the Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC) will be important signals of the regulatory direction we can expect a Trump administration to pursue. Steven Mnuchin, who has been nominated as Treasury Secretary for the incoming administration, has echoed Trump’s view on the Dodd-Frank Act, stating his ‘number one priority’ will be to reduce aspects that prevent bank lending.
The Trump administration’s regulatory agenda could have global implications. Fed Governor Daniel Tarullo, who also serves as Chair of the US Federal Financial Institutions Examination Council (FFIEC), has been an influential proponent of harmonization of global banking regulations. However, Tarullo’s term as FFIEC chair ends in March 2017 and Trump seems likely to push for a new chair more aligned with his agenda. A softer US regulatory approach, plus less push for regulatory harmonization from the US, could provide an environment where European and UK banks, which have digested more than 80 new rules and pieces of legislation between 2007 and 2015, are able to press for less regulation going forward.
The outlook for the UK banking sector will remain uncertain into 2017 as the government and policymakers decide whether to continue to adopt EU regulatory standards without being able to influence them, or whether to diverge and establish a less stringent regulatory framework. Retaining membership of the single market would see continued harmonization of regulations across all sectors, notably banking, and enable UK banks to continue to passport financial goods and services across Europe. That being said, we cannot assume exiting the single market will result in regulatory divergence.
In the US, amendments to existing financial regulations may spur loan growth and help to offset tightening of financial conditions arising from higher rates and a higher currency. A softer regulatory stance may also encourage loan growth in Europe, where reliance on bank lending is greater. Demand for loans from businesses and households remains weak, and we continue to expect growth and inflation to lack any upward momentum into 2017. In the UK, regardless of the regulatory direction, we expect the trend of rising compliance costs to continue in the near term. This, combined with a weak growth and inflation outlook, as the Brexit impact begins to play out, will weigh on profitability prospects.
Europe Has Historically Been More Reliant on Bank Lending than the US
Source: Haver Analytics, Federal Reserve, European Central Bank. Based on 2014 data.
China’s Regulatory Agenda
China is attempting to balance stimulus and reform against a backdrop of slower growth and capital outflows. Policymakers have pursued a combination of easy liquidity and fiscal stimulus. This policy mix is driving higher leverage in state-sponsored sectors, a hunt for return by the private sector and capital outflows as domestic investors seek to diversify out of China.
We think the Chinese government is committed to reform, including anti-corruption measures and measures to promote industrial restructuring to reduce excess capacity in sectors such as coal and steel. Significant changes are unlikely to occur ahead of the Communist Party Congress in the fall, when President Xi Jinping will have an opportunity to consolidate power.
Ahead of the Congress, we expect China’s regulatory agenda to focus on stability rather than reform. We think this direction has been evident in recent changes. For example, in late November, the State Council announced new measures to tighten corporate overseas direct investment, which will be in effect until September 2017. These measures are largely aimed at reducing overseas investment as a channel for capital outflows by companies looking to move money offshore. Similarly, policymakers have introduced several measures to tighten real estate regulations since August, including restrictions on ownership and land sales as well as higher down-payment requirements.
China faces a growth drag from reduced trade, a further increase in imbalances from policies designed to support growth while reforms are put on hold ahead of the fall Congress and increased pressure from capital outflows. We see no obvious catalyst for China-induced volatility, but we are cautious of the view that the government’s focus on stability means China is unlikely to be a major source of market volatility in 2017. In our view, medium-term risks from China are likely to get worse and the timing of an eventual reckoning is shifting closer.
China Focusing on Stimulus and Stability Ahead of Communist Party Congress
Source: Bloomberg. As of October 2016.
After years of relatively predictable economic policymaking, 2016 has been a steep inflection point. Given uncertain political dynamics around the globe, we believe staying nimble in industry allocations and responsive to changing market dynamics will be critical in the coming years.
—Dennis Walsh, Portfolio Manager, Quantitative Investment Strategies
The ultimate direction of energy policy that Trump’s administration will pursue remains highly uncertain, though the immediate perception appears to be supportive of hydrocarbons, while adverse for renewables. Trump’s ‘America First’ energy plan involves support for domestic oil and gas production, which will be put into action through lessening of regulations which hinder exploration. Trump has also vowed to allow the US energy infrastructure build-out to move ahead with greater ease. Meanwhile, the policy outlook for renewable energy is unclear; elimination of tax incentives which encourage investment in renewable energy could be disadvantageous, though corporate focus on the climate change agenda could support the industry.
On Healthcare, Trump was vocal about a “repeal and replace” of the Affordable Care Act (“ACA”) during his campaign but potential changes are unclear. While parts of the ACA may be retained, we expect modifications given Republican control of both the White House and Congress. Economic consequences will depend on the exact details. Since the ACA was implemented in 2014, the expansion of coverage boosted healthcare service consumption and its contribution to GDP. A repeal could result in a decline in covered population and subsidies, reducing demand. Elevated uncertainty while we await policy direction could also hamper investment and hiring decisions.
Energy de-regulation would be a clear positive for US energy companies, with federally regulated midstream companies such as pipelines likely to be among the biggest beneficiaries of the potential policy shift. Plans to scale back emissions-reduction targets would be encouraging for gas demand and incentivize investment in power and chemicals. We see limited near- to medium-term impact on renewable companies as much of the current approved legislation provides support for the next few years. Furthermore, renewable goals are set at the State level, many of which have reaffirmed support for renewables.
Cross currents in Healthcare sector make the potential investment impact varied and complex. We expect lower industry volumes to be broadly negative for healthcare providers and facilities. On the other hand, we expect health insurers may benefit from expansion of private-market Medicare under favorable Republican policies. Pharmaceuticals may also benefit, since Trump has voiced less scrutiny on drug pricing than his Democrat counterparts.
Affordable Care Act Repeal Could Affect Demand for Healthcare Services
Source: US National Center for Health Statistics. 2016 as of Q2 2016.