Trump Reform & Where Are We Headed January 2017

In Podcasts by в0 Comments

Trump Reform & Where Are We Headed January 2017 – Transcription

Now that President Donald Trump has taken office, how will the markets react to his proposed major reforms i.e. infrastructure, lowering corporate taxes, repatriation and renegotiation of trade deals.

Which proposed reform will have the greatest effect on the US markets?

What are the potential market ramifications to modifying trade deals with China?

The markets are overpriced already, where are we headed 6 months to 1 year down the line?

Full Transcript:

Good morning SizeTraders, how is it going? This is Amos here with Gary, the head trader at SizeTrade. Gary, thanks for being with us today.

Just a couple of quick questions; Inauguration was this past Friday and there was a lot of talk during the campaign about some major reform under Donald Trump’s campaign. We have a major infrastructure bill that he wanted to pass, lower corporate taxes, and repatriation and renegotiation of trade deals with Canada, Mexico and China. Also, there’s talk about healthcare overall.

My first question is what’s the priority for the market? And secondly, we also talked a lot about earnings per share and how they’re historically high. Even though we’re in a holding pattern at this point, we see here that the market’s priced very high, it’s the highest it has ever been and one could make the argument that some of the bills he’s going to pass are going to be a positive for the market. Still, the question is how does Donald Trump’s presidency play out in your opinion? What are we looking at long term, 6 months to a year down the line?

Hey Amos. Hey SizeTraders.

So, you talked about a lot of really important things and basically the entire new agenda of the new incoming president. I think the market is optimistic that he is going to tackle infrastructures and reform taxes pretty quickly. He has made it pretty clear that his agenda is repealing and replacing Obama Care, which I think he already passed a bill to do that. I think secondarily, his next agenda is to stop loosing jobs, which he calls:’’ make America great again’’ and bringing jobs back to America.

Let’s say he does that and he brings back 500 jobs here, a thousand jobs there, 500 here, how does that really affect the market space nationally in America?

Well, in my opinion, you have a lot of people who have different opinions on this. A lot of economists differ. I’ve been pretty right on my calls. I don’t want to say I’m always right, but I’m confident with the way I feel. I think this is going to be a net positive for America. I think you’re going to see a lot of instability around the world, particularly in Mexico and potentially China. These are countries that have really benefited in the last 10 to 20 years in a very strong way by having American jobs being sent overseas.

China has become the second largest economy, partly because they have big corporations from the US, Europe and all around the world bringing the manufacturing base into China. China is a communist country and their priority is employment. Employment keeps China stable. They’ve mentioned it in the past; they aren’t trying to hide it. Their promise to the people is:’’ We’re going to take certain rights form you, but we’re going to guarantee you a living wage and we are going to guarantee you work.’’ I think that’s the biggest problem China has; it needs to keep people at work because that’s what people are willing to give a lot of freedom for. To live in a communist and socialist country, they want to have a job and live all right.

So just de facto by hurting China in some sort of trade deal, America already benefits?

Well, I wouldn’t say that. Actually, I would quite say the opposite in this scenario. If China, the second largest economy and probably one of the pillars of growth in the world right now, goes into recession or some type of crisis, it would affect the US companies negatively. Also, if the US does put on some type of import tax or trade tax, China will probably do something similar or even be harsher because they have a lot more control over their corporations and people, since it is a socialist and communist economy.

Now saying all of that, the negative sides, the positive is Apple is not going to stop building iPhones because they need to move their maker base from China to America. Corporations are not going to stop creating stuff because they have to increase wages by 10$ an hour. They might look for innovations like robotics and so on, which is actually a positive for the US economy. That’s what makes US economy always grow; we are the leader in innovation. Something that we’ve kind of stalled in a lot of ways; we innovated with the car, with Internet and so on. A lot of the innovations in the 20th century were based in America. If you look at it, America is leading the world in a lot of innovations today, including electric cars with Tesla, Facebook and social media; really changing the world of marketing and putting it upside down from traditional marketing.

However, the problem is that you need a problem based on cost to spur innovation. Innovation doesn’t spur itself. Let’s take oil for an example. Since the middle of 1980’s until the late 90’ and early 2000’, oil was at a very low price. This spotted any innovations by companies trying to figure out how to get oil out of the ground cheaply. There just wasn’t money in it. Big companies like Exxon and Chevron didn’t put money into research and development because they weren’t making enough. A well of oil was 19$ a barrel. Now, fast forward 5 year out, the oil spikes partly due because the demand decreases from China, the dollar falls, there is some supplies disruptions and oil prices spike to 50 and eventually 100 with a small blow pop to 150. This allows companies such as Chevron, Exxon and other companies to invest now in research and development. Companies are trying to figure out how to get this oil that’s really expensive, at $100 a barrel, and it makes sense to spend two million dollars figuring out how to get more out of it.

This pretty much spurs on Shell or horizontal drilling, which now increases production in the US, taking us up to 10 millions barrels per day, and crashes world prices to a lower level. So now, innovation slows down as you heard in the last year, if you listen to any of these correlating things. Research development is down, spending on infrastructure is down and there’s nobody looking to do it. Before, they were talking about drilling into Arctic when prices were around a hundred dollars because the idea was that eventually, the prices would get to 150 or 200 and we needed the technology to be able to go to Arctic and get oil out cheaply or cheaper than $150 or $200 a barrel. When oil prices dropped to $40 or $50, every single company paused on the Arctic drilling research and development. So basically, that’s an example of when the prices go up, companies spend on innovation and innovators innovate. That’s one of America’s great strengths. A lot of people believe they’ll innovate in robotics because robots could displace regular manufacturing jobs and it would be cheaper than paying a wage of $15 to $20 an hour plus benefits; it becomes cheaper. So America will now invest in robotics if that happens. That will create jobs in robotics and an industry in robotics. Yes, it will kill the manufacturing worker but we’ll create better jobs and that’s always been the mantra of the US. Yes, we have a little bit of pain, but we switch from one to the other pretty quickly. For example, Internet was supposed to take out a lot of jobs, but now, we see that Internet actually created a lot of jobs and a lot of wealth while, on the way, lowering jobs. Now you have big retail stores closing down because people buy online, but you have a tons more programmers and app developers etc. that probably make a better living that they made before.

We all feel and agree that American wages need to go up. As the wages go up, those people will consume more. There’s a lot of different ways that economists argue how to get that done. The first way was to inject a ton of capital into the markets by quantitative easing by the Federal Reserve, basically creating reserves. They were hoping that we’d trickle down to corporations, which would trickle down to the consumer, which would make the consumer consume more, which would push up the growth rate, which would make companies hire more and make more money and so on. That obviously didn’t work. Banks hoarded that money and would only lend to the top echelon. The top echelon would invest in real estate and stock market, pushing certain asset classes up. People who benefit from those asset classes are typically the top 10 percentile of America and top one percentile of the world). So the rich got richer, the poor and middle class got poorer. That reacted inequality.

I don’t believe the Federal Reserve thinks quantitative easing is a good tool. It’s an emergency tool in their toolbox I believe. So now, how else can we raise minimum wage to increase consumption? What are the ways by bringing job back? So if Apple has to bring back all the manufacturing jobs to build iPhones, they’d bring back 30 to 100 thousand jobs; I don’t know what the number actually is. Now all of a sudden, all the companies do that at the same time and unemployment being at 4.7%, you can argue that the real unemployment is higher, people come back into the workforce and unemployment rate will fall. You’ll see pressure on wages right? So, one company like Apple will be willing to pay their manufacturing workers a couple dollars more because they need to get these iPhones done since they make $200-$300 per iPhone. Even if it costs them an extra dollar, 10 cent or 20 cents, I don’t know how many iPhone they can do per hour, but I’m sure it’s more than one. So even if it pushed up their price per phone by a dollar, they’re still saving $200 because they’re meeting the demand; it makes sense. So basically, Apple earnings might go down because it costs them a dollar more to build a phone, but they’re still making from $150 to $250 per phone, depending on which phone you take. So it’s a de minimis amount that Apple would definitely be willing to take on to continue to meet demands.

So as they’re willing to pay more, somebody with smaller margins, let’s say 3$ margins, might find it a little harder to keep up with Apple and pay the extra dollar because now they’re giving up a third of their profit margins. In reality, the question of free economics is, should that company be around if their margins are only two or three dollars per piece? In that case, a lot of these companies should go out of business and we would have a much more efficient market where you don’t have everybody fighting for that last dollar and causing a deflationary situation which has been the plague of the world, and the US particularly for the last eight years since the recession.

So now, the positive is for America. You bring back jobs and you increase wages. Wages go up organically now because congress said you have to pay them more. You have to look at it as fighting a problem. So if you fight a problem and you say, okay we’re going to raise minimum wage, corporations will just figure out how to send more jobs overseas because the difference between what they paid in America and what they pay in Mexico and China becomes greater. So, it makes more sense for them and it gives then a better incentive to send more jobs overseas. If you do it organically by bringing back jobs and companies not being able to fill the manufacturing needs and the demand of their product, they will organically raise their prices to make sure that they can fill the demand. Then, once you have that, congress can come in and raise minimum wage if they want to because anyways, the majority of the manufacturing bases are now getting paid higher than minimum wage. That’s the difference between the left and the right; it’s how you look at the problem. The left believes that the government should install certain fallbacks and the republicans, in the right, believe that you should organically increase stuff like minimum wage.

So let me ask you Gary, out of the major campaigns that Donald Trump had, which one of them is the priority that will dictate where the market is going to move?

I think the market want corporate taxes done relatively quickly. That’s something that you don’t have to do anything on and you can increase earnings per share by 5% easily. So if you cut the corporate tax rate, defective corporate tax rate by 5%, you’ve increased earning by 5%. You don’t have to sell or buy more, change any part of their business. They do it and it happens automatically. Within the year, they make 5% more.

Okay, so you cut corporate taxes, but what about balancing the deficit? Does the market care about that?

No, the market doesn’t care at all about that right now. Interest rates are low; the market would only care about that if you get a spike in interest rate like you saw in resource of other credit countries like Italy and Spain. That would affect it but as long as people are willing to buy US dollars expensively but at cheap rates, the market doesn’t care. The market doesn’t care about deficit because it is not looking out 10-15 years at what necessarily is best for the world economy and the US economy. The market only cares about how we’re going to get corporate earnings in six months, one year or two years. Corporate debt is not a problem right now. A lot of people say: ‘‘it’s a bubble which will eventually pop’’, but the 10 years bounce is not really a problem because they’re expecting a little bit more. Well, 10 years went down and the 10 years yield bounced because they’re expecting a little bit more inflation but you can still believe that 2.5% on a 10 year, which is historically really long. The market is not really concerned. Maybe if we get above 3% to 4% and we don’t see earnings growth that the market expects; we stay at the 2% rate but the yields get that high, then the market will start concentrating on that because it means that it’ll be more expensive to pay off the debts for the US government, which mean they’ll probably have to start cutting back on certain spending which will obviously lower the growth rate, the GDP of the country.

So for now, our market doesn’t care much about deficits, it cares more about infrastructure, corporate tax reforms and repatriation of money. I think their priority is their tax rate because, like I said, that’s something that corporations don’t have to do anything for. They get a pure 5-10% bump in their earnings per share, which makes marking go higher obviously.

And you’re saying that is already priced in, in the market right now or how much of that is priced in?

Well, I’ve seen earnings per share that have gone up a little bit. They’re up at 1.23 and some analysts are putting it into their numbers while other analysts are not. At 1.23, you’re probably looking at a 7% to 10% increase in earnings per share over 2016, but what you’re starting to see is that we are trading at 18 times those numbers. So, those are optimistic numbers with certain things prices in. So what ends up happening is that 18 times, you are at historically high ends of where earnings should be. Traditionally, over the last few years, earnings have come down because analysts have been over optimistic. So, if you see verdicts come down from 1.23 to 1.18, you’re trading roughly at 19 times and plus earnings. That is a pretty rich multiple when you’re only growing the economy at 1.5% that are consistent bases and you’re in a eight years bull market, which a lot of people saying you’re getting longer the tooth. So, it’s an expensive market. Is it the most expensive market we’ve seen? No, obviously the 2000 NASDAQ, but we’re probably the richest we’ve been since definitely 2008. We might be even richer at this point depending on when earnings will come in. We might trading at a higher multiple than we were in 2008 and this might be the highest multiple since that insane Pi ratio expansion of Internet boom of 2000. Obviously, back then, the economy was growing at 4% to 5% on a consistent basis and now, we’re going at a 1.5%. Even if you look at 2008, we were growing consistently at 3% to 4%. Now, again, we’re growing at 1.5% to 2%.

So back to the original question Gary. Let’s say he passes these reforms through and he manages to cut and lower corporate taxes, the repatriation of money happens and everything else that he said he wanted to do, but we’re still historically high, where do you see us going six months to a year down the road?

It’s a really complicated question because even if does pass all these things, we don’t know how long it’s going to take and what rates he’s going to do. I think it’s anybody’s guess what that corporate tax rate will end up being. Obviously if he drops it at 9%, that will be a huge boom for earnings. If he’s only able to drop it at 5%, then it’s obviously smaller. If he’s only able to drop it 2 or 3%, then he’ll have less of an impact. Infrastructure builds, depending on how big that package will be and over how many years, will affect how smooth the GDP is. If we see a really big package of shelf ready projects that will have a positive effect in the next year, it will push GDP to 4% but then, we’ll slow down and go down to the 1.5-2%. Is it something that is going to pump up GDP by half a percent because it’s a longer term project, but it’s going to last for 3-4 years so instead for being at 1.5-2%, we’ll be at 2-2.5% but stay steady for the next years. So, there is a lot of unknowns and I think that why the market has been rage bound; there are so many unknowns that nobody feels confident enough to really push what they believe in. There are a lot of different potentials.

Even the Free-Trade Agreement; how will countries react? Is China, the second largest economy in the world, going to cut out all American companies? That would really hurt US companies. If Apple can’t sell iPhone in its largest market, that’d be tough. On the other hand, if this causes a severe recession in China, economically speaking, how do the Chinese react? Do they just print more money and do a lot more stimulus, which could be positive for world growth? Do they react by allowing some stuff to fail? A lot of their banks have really bad loads on their balance sheets that they’re just ignoring at this point. It’s socialist government; they’re not as open as we are. They could do a lot of tricks. So the question is, what do they do? Do they get more aggressive as Russia did and start showing its military strength in Asia affecting some of our allies? There’s a lot going on in the world geopolitically right that haven’t seen in a long time.

My personal feeling is that there is too much debt in the world and that is going to blow up at some point. I’m not saying that it’s going to happen this year, but at some point, we’re going to have a recession. There are always a recessions and I think the next recession will be as severe or more as the 2008 recession. The question is how is going to be divided around the world? America and Europe felt the last recession harder than China and Asia. If Trump is able to bring back jobs, then this recession will be harder for Asia. The question is, where is the severity of the next recession going to be? How do countries react?

Obviously, Russia, when oil prices were coming to a point of being $200 a barrel because the amount of the supplies that the US companies were putting on the market, reacted in a very aggressive way hoping to take internal pressure off of them. As he knew that their GDP would eventually contract, although he didn’t know exactly when because the supply and demand picture was imbalanced for a long time, he knew it was coming to an end and that, as long a oil prices stayed high, the US companies would continue to drill more, which would create more supply more the markets. So he took a pre-emptive strike and went to Ukraine and has 85% backing now because of that because even though the economy is in a recession, they’re trying to play out of that playbook and do something, as it sees a recession potentially coming in the near term if jobs start leaving. Do they try to get nationality based on the fact that they need to protect themselves against enemies, imaginary or not? How to they react? Second largest economy, there is a lot of wild cards there.

So, it’s hard to predict. I think the market has done a good job of predicting a lot of the positives and incorporating a lot of the positives into the market at this point. You can’t fight that; that’s what the market decided to do. It would change it at any time but that’s the basis of the market. I think that, if we don’t get a lot of the positives through the first three weeks of his presidency and he doesn’t talk about it to show that it’s a top priority for his agenda, the markets will back down a lot. I’m not saying crash or 10% pullback. I’m just saying that we’ll probably go down maybe 50% retracement of what we’ve had, maybe 100% retracement of the move we’ve had since the election as the markets kind of reprise and say maybe tax reform is not a 2017 thing, it’s a 2018 thing. I think there are a lot of negative surprises that can affect the markets. Corporate earning might go down because they’re bringing back wages, even though it’ll be small. The dollar could continue to gain strength if we do bring back more jobs. Interest rates will go up because people will assume the growth rate and the dollar will strengthen. That’s going to hurt a lot of our exporters so earnings could go down based on that basis. We could see a lot of problems if China cuts us out of their economy. Our corporates, if it makes it stricter for US companies to sell in China. It’s the second largest economy; it’s a huge economy for American corporations. So there’s a lot of things that can go wrong that the market in not pricing in yet. I’m not going to say that those are going to be priced anytime soon, but something to keep and eye on. If that fear starts creeping in and people start thinking about it, they’re going to want to take profit and bares are going to get a little bit more bolted to start pushing it down.

Now, the question is, where do bulls feel comfortable buying this on a pullback? How confident do they feel that will eventually get corporate tax reform and infrastructure package. If they feel very confident, they might not be bidding much lower than what we are right now.

Gary, thank you so much for your time. We’ll stay tuned and as always, try to subscribe and we’ll keep you updated. Until next time, this is Amos with Gary, head trader at Take care.

Take care.

Leave a Comment