Although some earnings reports have beaten expectations, it’s surprising to see the stock market whistling passed the grave yard as uncertainty on the fiscal front is heightened. Trump’s presidential legacy will be made in the next few months.
The worst-case scenario would be a government shutdown with no tax cut and healthcare plan passed. The base case would be no shut down and moderate tax reforms such as a small corporate tax cut and some reforms to Obamacare. The best-case would be a no government shut-down, a complete overhaul of the tax code which gets rid of loopholes and lowers the rate for individuals and corporations, and the American Healthcare Act being passed with some reforms which puts those with pre-existing conditions into high risk pools to take care of them while cutting costs for everyone else. Because there haven’t been any legislative victories by the GOP in Trump’s first 97 days, everything if on the line. This makes the range of possibilities wider than usual.
The specifics of the negotiations need to be monitored closely because there’s so much on the line. The market isn’t reacting to the plans as it’s focused on earnings season. This doesn’t mean you should ignore it as well because once it’s clear how everything will play out, the market will react. It’s possible that the market isn’t reacting to the changes because all the information we have is based on tenuous negotiations which can go either way regardless of reporting or what officials say.
The first issue to focus on is the debt ceiling debate. The deadline to make a deal is this Friday. I have mentioned that I expect a temporary funding plan until the fall, but the issue is slightly more complicated than that. Firstly, the President wants to get some legislative victories by his 100th day in office especially since his approval rating is dipping to the low 40s. This Friday can be a rough for the President if only a temporary stop gap is agreed upon because the weak Q1 GDP report will be released that day as well. I’m working under the assumption that President Trump is being advised that the report will be weak.
Getting into the specifics of the debt ceiling debate, the GOP has stopped asking for border wall funding and it has cut its ask for defense spending to increase from $30 billion to $15 billion. Because the plan needs votes from Democrats and they have leverage because of Trump’s weak approval rating, they are asking for either $15 billion in supplemental non-defense spending or funding for Obamacare insurance subsidies which will cost about $10 billion. This makes the negotiations difficult for Paul Ryan because he wants the military spending, but many in the GOP don’t want to fund what are called cost-sharing reductions for Obamacare. The most difficult part of Paul Ryan’s ability to make a deal is that many moderates support funding for these subsidies because without them, insurance rates will go up. As I said, the usual tendency for politicians to kick the can down the road isn’t a great option because Trump wants legislative victories. Passing a temporary stop gap would be the opposite of a victory.
One of the biggest themes of this process is that President Trump is motivated to get things done while Congressional Republicans are more worried about passing something which hurts their re-election chances. Trump likely believes he can sell any legislation of significance to the voters while Congress is more skeptical; they think passing a bad deal would be worse than no deal.
There aren’t any upside scenarios for stocks in terms of the debt ceiling. It’s more about avoiding disaster. The market obviously wants the debt ceiling to be raised as quick as possible. The best deal for the market would be if the GOP agrees with funding Obamacare insurance subsidies because without them, the GOP will have to pass healthcare reform to prevent premiums from rising. As I’ve mentioned, the chances of healthcare reform look brighter recently, but the market wouldn’t want to rely on something uncertain. Premium increases decrease the consumer’s discretionary spending budget.
The healthcare plan’s passage depends on how the moderates vote. Waiving the community rating requirements, which puts those with pre-existing conditions in high-risk pools instead of covering them with normally priced premiums, appeals to the House Freedom Caucus members, but not to moderates. There were a few moderates who opposed the American Healthcare Act’s first iteration, so they won’t be swayed. The key will be whether any new moderates switch their votes from “yes” to “no” because of this shift to the conservative side. Some moderates have expressed their desire to make it look like the GOP can govern. They would vote in favor of the new bill. Others want to make sure their constituents receive the Medicaid expansion which would be removed under the new American Healthcare Act. They would oppose the new bill. I’m basing my assumption that the new iteration will be closer to passing than the first try because moderates tend to be part of the establishment. The establishment usually wants to get legislation passed and is supportive of Congressional leadership.
The latest leaked reports from Trump’s speech on Wednesday is he will support a 10% repatriation tax. This temporary tax cut is the best part of the plan for stocks because the money will be used to fund buybacks. It’s popular because it will raise revenues to pay for income tax cuts or infrastructure spending. It’s estimated that there’s $2.6 trillion in offshore capital. The House supports an 8.75% rate on earnings held in cash overseas and a 3.5% rate on invested earnings. Both are great plans for stocks.
The latest analysis on the potential tax plan is even worse than previously supported. A 3-year 20% tax rate without a border tax would increase the deficit outside the 10-year budget window which would make it need Democrat support which it won’t get. Trump is proposing a 15% tax rate which has even longer odds of passing. This math is why the House has been supporting a plan which has a 20% tax rate and a border tax.