Global Market Commentary

December 15, 2016

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For the U.S. Economy to Grow, Productivity Must Rise — But

The Obama administration aimed to increase U.S. labor productivity; and the incoming Trump administration has the same goal.  Although the goal is the same, their prescriptions are different. Here is our list of industries to own and to avoid.

Economists generally agree that for a nation’s standard of living to improve, labor productivity must rise faster than inflation.  

Such productivity growth creates jobs, increases economic growth, and improves the living standards of the poor — lifting their income and economic status.  In turn, rising living standards grow the middle class, stabilize and enhance middle-class values, make the nation more stable, and ultimately set the stage for even greater growth.

In the U.S. and much of the developed world, historians, policymakers, and economists accept this productivity-centered model of economic growth and development.  In the U.S. there have historically been two basic strategies to support growing labor productivity, and we will briefly outline them in this note.  

We are not judging which of these basic strategies is more effective and which is less.  We are observing that over the past eight years, we have had one political model, and for the next four years, we will have a different one.

We will have an opportunity over the next four years to judge which model works better on the basis of the results.  In the meantime, investors will have to work with the model put in place by the incoming administration.  Understanding how the proponents of each strategy see the world, and how each allocates government resources, will help us predict which industries and companies are going to be attractive for investment during the next four years.

Two Paths to Productivity Growth

First, we’ll describe the model employed by the Obama administration.  Put simply, under this model, the government increases taxes on businesses, the wealthy, and the middle class, and offers subsidies to the poor.  Government sees itself as the bulwark of employment and tries to create jobs by expanding government and government-related employment opportunities.  Those who employ this strategy seek to use regulation to assure an even playing field for all economic participants.

The second model, on the other hand, is the one taking shape in the policy proposals and cabinet picks of the incoming Trump administration.  In this model, entrepreneurship and private-sector employment are the preferred engines of job creation, with incentives to growth offered to business through lower taxes and less regulation.

(When Mr. Obama was elected President, we read both of his autobiographies.  Now that Mr. Trump has been elected, we have read his The Art of the Deal and are starting another of his books.  In both cases, we gained valuable insight into each man’s concerns and ideas.)

Industries That Could Benefit From the New Policy Framework

We believe the following industries would be supported in the near term (the next year or two) by currently planned Trump administration policies.

1.  Consumer companies that benefit from a more optimistic outlook for U.S. economic growth will be benefitted immediately.  If people feel richer or more optimistic, they will spend on apparel and meals away from home.  However, retailing is also making a shift from in-person to online and mobile, so be very careful to focus on strong e-retailers, or retailers whose products are inconvenient to evaluate online, such as many cosmetics.

2.  Those which will benefit from a major cut in income taxes:  namely, most companies who operate exclusively in the U.S.  Those which have substantial foreign operations pay much of their non-U.S. tax in foreign countries where tax rates are closer to the global 20% average rather than the much higher 35% statutory U.S. rate.  This group includes many businesses that are domestically focused, in manufacturing, minerals and materials, transportation, shipping, business services, energy and energy-related, retail, technology, medical services, banking and financial services, and business services.

3.  Those which have endured increasingly intense regulation which will now moderate.  This will take longer, but may happen within a year or two.  Affected industries include banking, insurance, investment banking, mortgage insurance, mortgage finance, energy production, energy pipelines, and refiners.

Benefits would take longer — perhaps four years — to accrue to industries that will benefit from a major infrastructure bill: for example, industrial materials suppliers, construction companies, and construction equipment suppliers.  These depend upon a longer procurement and implementation process.  These will not see benefits in one or two years, but could by the time four years have passed.

Industries That Will Not Benefit From a Trump Presidency — We Suggest Avoiding Them

1.  Those whose business have a large percentage of their sales to the U.S. government will find their profits pressed by the incoming administration’s avowed intent to get better deals.  Mr. Trump has shown in his comments about pharma pricing and Boeing’s bill for the new Airforce One that he will demand the best price for goods bought by the U.S. government from private companies.  He is very proud of his ability to negotiate low prices.  He loves to negotiate, and he likes to feel that he and his organization got the best price.  We expect him to work hard to create this psychology among U.S. procurement officials, and he will pressure them to lower the prices they pay for goods.  Avoid companies where a large part of their revenues are derived from supplying the U.S. government.  Their revenues may rise but their profits will be under pressure.

2.  Those companies that continue to move operations overseas will struggle against the new administration’s agenda of keeping manufacturing in the U.S.  The President-Elect’s “bully pulpit” approach makes free-market advocates very nervous.  He argues that lower taxes and the implementation of activist trade practices will boost sales for U.S. manufacturers, even though U.S. labor costs are much higher than those abroad.

Investment implications:  When labor productivity rises faster than inflation, so do living standards.  That’s why U.S. administrations of every political orientation seek to boost labor productivity.  However, they pursue this goal with very different strategies.  For the past eight years, the U.S. followed a strategy focused on government as the engine of employment and productivity growth through expanded programs, more stringent regulations, and higher taxes; now the country is shifting gears to a new strategy based on the incentivizing of the private sector through tax cuts and selective deregulation.  No matter which strategy is judged by history to have been more successful, investors must simply adapt to the environment as it changes — and the new environment suggests that a very different set of winners and losers will emerge in the coming months and years.  We believe the winners in the next year or two will include consumer companies that can benefit from a sharp increase in consumer confidence; companies whose earnings derive primarily from the U.S. and can benefit the most from corporate tax cuts; and those who will see a relaxation of regulations that had grown over the last eight years.  Over a longer period, perhaps four years, benefits could accrue to companies that will benefit from a major infrastructure bill.  We are cautious of businesses that get a lot of their earnings from sales to government, since the incoming administration has signaled a tough bargaining stance.  Businesses which continue to shift operations overseas could also face headwinds from a domestically focused Trump “bully pulpit,” and we would avoid them.