The post-Trump election rally continued into the first quarter of 2017, but tapered off a bit in March 2017. Many of the active equity managers who struggled to keep pace with the rally at the end of 2016 outperformed in the first quarter of 2017. The broad market indices have produced returns between 10-20% during the current market rally from November 8, 2016, to June 7, 2017. The leading sectors during this period have been Financials (especially banks), Consumer Discretionary, Industrials, and Information Technology. Active equity managers who have been underweight these sectors have trailed the broad market benchmarks as a result.

A survey of our MAX managers* revealed their view that while stock valuations appear stretched in the U.S., some believe current valuations could be supported by corporate U.S. tax cuts, less regulation, savings from health care reform, and the potential $1 trillion of infrastructure spending. However, current stock valuations are at risk if the policies do not come to fruition. The S&P 500’s forward P/E ratio of 17.5x is above the 10-year average of 14.0x. Even though the Chicago Board Options Exchange (CBOE) Volatility Index (“VIX”), also known as the fear index, has been near an all-time low recently, volatility did pick up a little in mid-May 2017. It’s worth noting that it’s a bit strange to see a high P/E ratio for stocks and very low volatility at the same time.

Trump Policies & Potential Market Impacts

U.S. Corporate Tax Cuts

The highest U.S. corporate tax rate is currently 35%. Trump is proposing a cut that would lower the rate to 15%. However, a 20-25% range seems more likely once Congress has its say in the matter. It is worth noting that some deductions would be changed and/or removed, which could negate some of the tax cut benefit for some companies. The proposed tax cut could be an overall positive for companies with a large percentage of their revenues in the U.S. The largest beneficiaries would be companies that currently pay 30-35% in taxes; non-profitable firms would not be impacted. The average tax rate for companies in the S&P 500 is 29%.

Cash Repatriation Plan

The Trump administration is in favor of allowing repatriation of cash balances held in foreign lands by U.S. companies at a lower tax rate than today. Many U.S. companies that have profits outside the U.S. have kept those profits or cash offshore instead of bringing it to the U.S. in order to avoid having it be taxed at regular U.S. tax rates. The administration is considering taxing these offshore cash balances at a lower rate (between 0% – 10% versus 20% – 25% today) when companies bring the cash back to the U.S. The idea is that this will help spur domestic growth as companies spend that cash to build factories, expand growth initiatives, and create jobs.

However, some managers as well as financial experts believe that companies are more likely to spend the cash on stock buybacks, dividends, and mergers & acquisitions, which do not directly stimulate growth. As asset managers have been talking with their portfolio company CEOs, some of the CEOs have noted they are holding back on parts of their business plans, including spending, given the potential of being able to bring back offshore cash to the U.S. at a lower tax rate.

The estimated cash held offshore by U.S. non-financial companies is over $1.2 trillion. Below, we have listed the cash balances of some of the largest U.S. firms that hold cash offshore.

Company and Offshore Cash Level

• Apple: >$230 B
• Microsoft: >$120 B
• Cisco Systems: >$60 B
• Google (Alphabet): >$58 B
• Oracle: >$50 B
• Amgen: >$30 B
• Facebook: >$25 B

Source: Investment managers

Affordable Care Act and Drug Pricing Reform

Repealing the Affordable Care Act (the ACA, or “Obamacare”) would have both positive and negative consequences for hospitals, managed care companies, medical device firms, and insurance companies. However, it appears that we may be a long way from a new health care bill becoming law and replacing the ACA. Regarding drug pricing, both Republicans and Democrats seem to agree that lower drug pricing from the health care sector is in the public’s best interest. Lower drug pricing is likely to impact the distributors more than the actual pharmaceutical and bio-tech companies that produce the drug products. Health care is complicated and change is likely to be gradual.

Final Thoughts

Equity managers we surveyed believe that Trump’s policies will take longer than expected to fully implement, especially due to the differing opinions in the House and Senate. Furthermore, most agree that the Fed is likely to continue raising interest rates gradually. The stock market has priced in, to some degree, the potential corporate U.S. tax cuts as well as the Trump administration’s pro-business agenda; therefore, equities are at risk if these policies are not entirely implemented.

* Callan’s Middle Market Matrix – MAX – is a collection of separate account managers and mutual funds, categorized by investment style, that have passed Callan’s thorough due diligence process as managed by our Independent Adviser Group.