The traditional Achilles’ Heel of most US fiscal expansions has tended to be that some part of the extra income generated from the initial spending programme have been spent on imports (indeed, we calculate that the marginal propensity to import during the first half of the 1980s was over unity).   Therefore, we wonder if Trump’s team is implicitly hoping to keep the extra income that any increase in spending that his infrastructure and tax cuts generate within the economy through the use of border taxes and the like. 

There was of course a time during which the markets would have baulked at the thought of an increase in government involvement in the economy (via more spending) and an increased level of regulation and control of free trade but times are clearly changed.  Markets instead seem to want to focus on the notional outlook for domestic profits.

However, we must note that the outlook for profits under Trump is anything but clear at this time and this is not only the result of the lack of details over any forthcoming tax reforms and the questions over the actual physical ability of the government to enact an infrastructure spending programme without the economy grinding to a grid-lock-inspired halt.

For the sake of the analysis, we shall assume that Trump does manage to spend an extra $200 billion per annum through public sector expenditure and that net tax receipts fall by $100 billion in the first year as a result of the promised tax cuts.  We shall further assume, rather heroically, that the current account balance improves by $100 billion as a result of any new trade policies.

On the basis of this maths, the economy should therefore gain a $1 trillion net injection over the next four years.  This net injection should lift national incomes by the same amount and also for the sake of argument we shall at this stage assume that the ‘windfall’ is shared evenly between ‘capital and labour’.  Where this to occur, then domestic corporate profits should rise by an “extra” 29% over the next four years, if other things remain equal.  However, in economics, other things rarely remain equal.

The two primary imponderables revolve around private sector investment and saving trends.  During the late 1960s, and early 1970s, it was ‘fashionable’ to assume that an increase in fiscal spending would revive private sector ‘animal spirits’ and in so doing pave the way for an expansion in domestic investment that augmented the positive effects of the fiscal expansion.  This view of course became less popular as the 1970s continued and by the early 1980s it became trendy to believe that wider fiscal deficits would in fact lead households to assume (not unreasonably) that their future tax liabilities would increase and that this would cause them to save more (the so-called Ricardian Equivalence Theorem - RET).  Intuitively, we have never felt entirely comfortable with the RET analysis but there does seem to be some empirical evidence to support the Theory.

What we do know is that during the large budget deficit period of the 1980s, when house prices were rising moderately rather than booming, when interest rates and inflation were in general higher, when savers were less convinced that they would experience perpetual capital gains on their asset holdings that they would be able to realize at will, and when the distribution of income and wealth was significantly more equitable than it is today, the US household sector generally saved around 7 – 8% of its disposable incomes (versus the 5 – 6% of their incomes that they save at present.  We could therefore argue that if Trump is going to notionally ‘normalize’ the economy over his tenure, then US personal savings should rise by about $250 billion.

Were this increase in personal savings to occur, then under the very same other assumptions that we outlined above, we could suggest that the net increase in US corporate profits that might be expected to result from Trump would be cut to around 15% over a four-year period (i.e. the average annual lift to profits would be of the order of 3.7%).  This number would rise if Trumponomics resulted in an increase in private CAPEX (which Reagonomics of course did not), or fall if the implied greater degree of implicit state control on the economy resulted in weaker CAPEX trends.  We would tend to assume the latter…

Finally, we suspect that the US economy is currently operating with a small negative output gap in the context of a trend rate of growth that may be a little below 2% per annum.  If Trump were to lift nominal expenditure by an ‘extra’ $1 trillion over the next four years, then we can assume that much of the increase in nominal incomes would in fact be lost to inflation, thereby implying that real incomes (particularly for the poorer high propensity to consume members of society) would tend not to increase unless wage inflation were to accelerate by more than we are assuming (i.e. at the expense of profits).  This would be a particularly likely scenario within the context of what may have by then become a relatively more closed economy.

Given these considerations, we are minded to believe that even if Trump ‘gets what he wants’ and furthermore that there is not an aggressive reaction to his policies from the US’s trading partners (that subdues US exports), then the likely lift to US corporate profits is likely to be between two and four percentage points of ‘extra’ growth on average over his first term (although the actual gains will be heavily front-loaded once any measures are introduced).  This hardly appears that significant in the grand scheme of things and, therefore, we remain convinced that it is funds flow and asset allocation trends (which remain positive at present) that are providing the lift to US equities at present. 

At present, the high level of dividend payments and (debt-financed) share buy-backs are supporting close to a $1.4 trillion ‘cash pay-out’ to the owners of US equities.  At the same time, and presumably as a result of their own rising expectations of inflation and dismay over the low level of deposit rates, US households are shifting out of bonds and into equities.  These factors on their own provide a simple but potentially compelling reason to expect US equities to continue to perform in the near term but, over the longer term, higher inflation and more state control tend not to be supportive of higher equity prices.  We would ride the Trump rally for a few months more but it is not something that we would expect to be sustained over the medium term.

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