What a Trump Win in 2024 Could Mean for Your Long-Term Savings
Unhedged decided to tactically exit the drama of US 10-year Treasury bond yields, which for some reason fell 9 basis points yesterday. Someone will let us know if anything important happens. Today we are listening to the drama of American politics that has just begun.
Trump's second term
We don't write much about politics on Unhedged because we have no political experience. We are only a few people who read the newspaper. But with recent polls suggesting that Donald Trump would beat Joe Biden if the presidential election were held today, we would be remiss not to discuss the impact on markets of a change in administration. So here we will proceed with caution and, in the words of another prominent politician, we will cross the river by feeling the rocks.
To help you, we spoke with two Unhedged friends who make a living helping Wall Street think about Washington: Ed Mills of Raymond James and Marko Papic of the Clocktower Group. We asked them what the main impact of a Trump victory would be for investors.
Mills argues that the main impacts of Trump II would be:
The tightening of regulations in the banking sector ceases. Since the mini-bank crisis in March, the trend towards stricter requirements for financing total capital and long-term debt has accelerated. But implementation, Mills said, won't happen until 2025, just in time for Trump-appointed regulators to abruptly backtrack.
Uncertain follow-up to the law on reducing inflation. Industrial companies investing in green energy and grid improvements need long-term certainty about tax incentives under the 2023 law. Ending the IRA would require new legislation, but the Trump administration would likely try.
Renew Trump's personal tax cuts. If Trump wins and Republicans take back the Senate, cuts that amounted to about $1,600 for every American family will likely continue. They expire at the end of 2025. As for Biden, Mills says, “everything is up for debate: the corporate tax rate, the maximum individual tax rate, the state and local tax credit.” The entire budget situation of the American government is at stake in these elections.
International investors' perceptions of the United States as an investment destination. At Unhedged, we often talk about the premium global investors pay for US assets. Mills sees this as the price to pay for political and legal stability. If a second Trump administration makes the political environment more partisan and policy outcomes less predictable, the premium could decline.
The three things Papic says will be the most important:
A new level of fiscal waste (assuming the Senate and House are Republican). Trump is a nationalist and populist and will spend and cut taxes without restriction, Papic says. This will raise inflation expectations and reduce bond prices. The only question is whether the bond market will take this into consideration next year or wait until Trump is elected.
A more flexible, but less efficient administrative state. “This time they really want to drain the swamp,” Papic says, and while that “suggests a simpler regulatory environment, it also suggests delays and lawsuits and back and forth: a simply slow administrative state.”
Protectionism, whether through tariffs or a weak currency. Trump has proposed a 10% tariff on all imported goods. It will encounter national and international resistance. However, an easier way to achieve the goals of these tariffs – in terms of rebuilding domestic production – is to weaken the dollar. Like Richard Nixon with his proposed import surtax, Trump could eliminate his tariffs and focus on the exchange rate (and possibly put political pressure on the Federal Reserve).
The 2 The lists are different, but coherent: regulatory and fiscal flexibility, associated with an element of uncertainty. One area where the two analysts disagree is the future of US-China relations. Mills believes relations could deteriorate because, although Biden has taken strong actions that have impacted Chinese interests, those actions have been clear and well communicated. Trump would be less predictable. Papic disagrees: He believes Trump's reputation for toughness toward China is so strong that he has a chance of striking a deal with the Chinese if he finds one that is beneficial to the United States.
There is much more to say on this topic. We are very interested in readers' opinions.
Small-Cap Earnings: Good
We had a very upbeat earnings report yesterday. Attitude expressed regarding the impact of interest rates on company balance sheets. There will be corporate crises related to interest rates (there have been a few in the past), but a major contagious conflagration seems unlikely.
However, this relaxed attitude may reflect the fact that we are primarily focused on large-cap US stocks. I was told that small caps were much more vulnerable. To test this idea, I ran analyzes (using S&P Capital IQ) of the large-cap S&P 500 and small-cap S&P 600 indexes. I analyzed leverage (measured as net debt/Ebitda) and interest expense coverage (measured as operating profit/interest expense). I excluded the financial sector, for which these measures generally do not work.
Regarding leverage, I found that in large-cap stocks, the ratio financial between 9% of companies (39 of 428) had a leverage ratio above 6, a traditional threshold for very high debt. For small caps it was 16% (79 out of 479).
The same pattern occurs with interest coverage, but it is more extreme. Only 6% of large companies have interest coverage of less than 1.5 times. For small-cap companies it was 19%, and many of these companies did not make operating profits.
Screens like this are just a bunch of numbers with no context. So I called two people who manage small-cap portfolios and asked if I was right that small-cap companies carry much higher interest rate risk.
James Mendelson, co-portfolio manager of GMO's small-cap quality strategy, agrees. “Yes, there is more influence in small caps,” he says. Additionally, more debt comes with variable interest rates, and more debt will come due soon. What is particularly strange is that the most indebted companies in the small-cap universe have not been particularly penalized by the market, despite the increase in interest rates.
Medelson's team recently divided small-cap U.S. stocks into quartiles based on leverage and compared the performance of the quartiles with the highest leverage high and those less indebted. They found that in the 12 months ending in October, the total returns of the most indebted quartile were just 6 percentage points lower than those of the least indebted quartile.
Is the large valuation difference between large- and small-cap companies justified (the S&P 600 is at a nearly 50% discount to the S&P 500)? Not entirely, according to Mendelson: Many small-cap companies are trading at low prices relative to their history, and not just large-cap companies. But you have to be selective.
“A significant percentage of small-cap companies are in a precarious situation, not only because of their debt, but also because of the structure of their balance sheet . maturity schedule and tighter credit standards,” said Bryant VanCronkhite, senior portfolio manager at Allspring Global Investments. “Many of these companies also don't have the EBITDA stability that large companies enjoy because they don't have diversity in their products and markets." There are times, he says, when the quality of the balance sheet and the stability of cash flows are not so important, but this is not one of them.
“The emphasis is on leverage and the coverage is not good enough. You need to think about the maturity schedule, contract packages and refinancing capacity,” explains VanCronkhite.
It will be interesting to see whether small-cap active managers can outperform their indices as they transition to a world of higher interest rates. It's time they deserve their due.< /div>