Our latest commentary outlines the key factors driving muni and corporate bond performance in November.
In the days following Trump's win, we take stock of the impact of a Trump presidency on the overall macroeconomy, the municipal bond market and the corporate bond market.
The surprise result of the U.S. election has prompted markets to rethink policy implications of a Trump presidency. Early indications of a Trump victory resulted in expected risk-off trading; global equities fell 5-10 percent and the U.S. Treasury 10-year yield declined 15bps. Following Trump’s conciliatory speech Tuesday night, the markets recovered and moved to more risk-on trading. The U.S. 10-year Treasury closed at 2.07 percent and U.S. equities were up over 1 percent Wednesday.
However, the outcome of a Trump presidency is uncertain from a policy perspective, and we expect it to take several days to process the impact of Trump’s win on the long-term economy. With a Republican House and Senate, we will most likely see the implementation of tax reform to lower rates and limit exemptions and deductions. Potential for fiscal stimulus and tax cuts have increased long-term inflation expectations. We will also see the start of momentum to reduce the penalty for bringing foreign corporate cash back to U.S. shores.
Other high-level thoughts:
- Trade policy and infrastructure investment were the key themes of Trump's acceptance speech Tuesday night, but specific funding for infrastructure spending remains unclear.
- The Affordable Care Act (ACA) is likely to be changed significantly, impacting state insurance programs, Medicare/Medicaid plans and individuals with ACA insurance.
We are in a new territory and will be monitoring market and policy developments closely. With the surprise election results, we face a potential turning point in issues impacting markets, such as Supreme Court appointee decisions and Fed rate hikes.
With a Trump presidency, investors will be watching potential impacts to municipal credit. For municipal investors, tax reform is a major focus given that the value of the muni tax exemption could be lowered. In our view, material policy change is likely within Trump's first 100 days. Trump’s election, along with a Republican Congress and Republican House, suggest that legislation will move next year.
We believe repeal of the Affordable Care Act (very likely, given the legislative template is already in place); more funding for infrastructure (likely, given that both parties have expressed demand for this); and tax reform (slightly less likely, given that eliminating tax preferences is often politically fraught) are the most likely near-term policy priorities that would impact municipal credit.
- ACA repeal is a credit negative for hospitals. Repealing the ACA should increase hospital bad debt expense as Medicaid rolls shrink and exchange subsidies are withdrawn. Hospitals in economically weak areas and in Medicaid expansion states are most at risk. ACA repeal is likely because Republicans passed a bill last year to repeal the ACA using the reconciliation process. Trump has promised that repealing the ACA would be a Day 1 priority, and House Speaker Ryan has proposed ACA repeal as part of his "A Better Way" plan. Republicans understand that removing 20 million people from insurance rolls is politically unpopular, but they believe they have a path to phase in a replacement.
- More infrastructure funding is likely, which could assist with the nation's backlog of infrastructure needs. Trump’s infrastructure plan calls for upwards of $1 trillion in federal investment, including a tripling of funding for existing clean water revolving loan programs. Federal subsidies would be delivered through a new tax credit program that incents private sector investment. The tax credit program would supplement existing (and past) financing methods, including tax-exempt bonds, Build America Bonds, and public-private partnerships. Some movement on infrastructure seems likely given that both presidential candidates favored increased spending on public works.
- Tax reform is a negative for the muni exemption. Trump is proposing lower tax rates and a broadening of the federal tax base. Lower rates would reduce the value of the muni tax exemption relative to other investments. Tax reform might also include curtailing or altering the existing exemption. Tax reform seems more probable than not because Speaker Ryan and President-elect Trump's tax plans are very similar. Both plans would lower rates and eliminate deductions and loopholes. Trump's plan would include three rate brackets: 12 percent, 25 percent and 33 percent. The capital gains tax rate would be 20 percent.
Trump's U.S. election victory has potential credit implications for a number of corporate sectors. The impact of Trump’s win will depend on the likelihood of real Federal policy shifts and changing regulations and laws. We think implications may initially be positive for Financials but more mixed for Industrials, depending on the sector. But overall, the companies we invest in are highly creditworthy and remain well positioned to weather changing U.S. and global political landscapes.
- Multinationals. Trump has proposed cutting corporate tax rates and implementing a one-time tax holiday to repatriate overseas corporate earnings and cash. If this happens, it will be positive for U.S. multinationals with large overseas cash holdings depending on how the new liquidity is utilized (e.g. capital expenditures, share buybacks, dividends and/or debt reduction).
- Banks/Insurers. Trump and certain Republicans have proposed repealing the 2010 Dodd-Frank Act. If repealed, regulatory oversight, compliance and risk management costs could decline for banks. Repeal could allow for thinner capital cushions and greater risk taking. This could support earnings near-term, but increase credit risk longer-term. Separately, the post-election move higher in U.S. Treasury rates is positive for banks and insurers.
- Exporters/Importers. Trump has indicated a desire to renegotiate certain overseas trade agreements. Ultimately, tariffs could be levied for certain products in some sectors. This could negatively impact some big U.S. exporters (e.g. aerospace, autos, energy, technology) and positively impact some domestic-oriented sectors (e.g. diversified manufacturing, textiles, retailers, steel).
- Construction/Defense. Trump has talked about increased infrastructure investment. If this comes to fruition it could be positive for construction machinery firms (e.g. Caterpillar and John Deere). Trump has called for eliminating the defense sequester, which may be positive for some defense companies (e.g. Boeing, Lockheed Martin).
- Pharma/Healthcare. A potential rolling back of the Affordable Care Act would be expected to negatively impact some Pharma/Health Care credits with a potential 22 million Americans losing health care coverage. However, this could be partially offset by a more favorable regulatory backdrop with respect to drug pricing.
- Energy. A Trump energy plan could roll back subsidies on renewable energy projects and allow for greater investment in pipelines and fossil fuels. Potentially less stringent environmental regulations could allow for expanded drilling opportunities, a positive for large energy firms.
Disclaimer: This material has been prepared for our clients and other interested parties and contains the opinions of Breckinridge Capital Advisors, Inc. Information and opinions are current as of the date(s) indicated and are subject to change without notice. Any specific securities or portfolio characteristics are for illustrative purposes and example only. They may not reflect historical, current or future investments in any client portfolio. Nothing in this document should be construed or relied upon as tax, legal or financial advice. All investments involve risk including loss of principal. An investor should consult with an investment professional before making any investment decisions. This document may include projections or other forward-looking statements, which are based on Breckinridge’s research, analysis, and assumptions. There can be no assurances that such projections will occur and the actual results may differ materially. Other events that were not taken into account in formulating such projections may occur and may significantly affect the returns or performance of any account. Past performance is not indicative of future results. This document includes information from companies not affiliated with Breckinridge (third party content). Breckinridge reasonably believes the third party content is reliable but cannot guarantee its accuracy or completeness.