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Investment Commentary

photoJan­u­ary 11, 2017

What Will Hap­pen Next?

Robert Brooke Zevin, Chair­man, Senior Port­fo­lio Manager

Sel­dom if ever has the pend­ing inau­gu­ra­tion of a new Amer­i­can Pres­i­dent pro­vided such a bewil­der­ing and uncer­tain array of pos­si­ble con­se­quences. There are as many areas of dan­ger in Trump’s threats and promises as there are cir­cles of Hell in Dante’s Inferno. For open­ers, the President-​elect has promised to esca­late the two most seri­ous threats to the sur­vival of our human species: global warm­ing and a renewed nuclear arms race. As America’s social, polit­i­cal, and cul­tural appeal declines in the rest of the world, and its mil­i­tary inter­ven­tions con­tinue to fail, there is a strong temp­ta­tion to build the “killer app” nuclear weapon sys­tem that would give the Amer­i­can Cen­tury another hun­dred years of dominance.

The envi­ron­ment is quite a dif­fer­ent story. The appoint­ment of cli­mate change deniers and fos­sil fuel indus­try cham­pi­ons to var­i­ous key posi­tions, includ­ing the Envi­ron­men­tal Pro­tec­tion Agency, nearly guar­an­tees that no fur­ther progress will be made at the fed­eral level. Mean­while, ordi­nary peo­ple and many busi­nesses will con­tinue, along with states and cities, to adopt green energy alter­na­tives because they address the global warm­ing calamity and, in many instances, are already com­pet­i­tive with con­ven­tion­ally gen­er­ated power.

Chang­ing the Rules

Trade and immi­gra­tion are high on Trump’s list. Regard­ing immi­gra­tion, on which Amer­i­can agri­cul­ture, upper-​middle-​class house­holds, and high-​tech busi­nesses all depend, Trump has left him­self plenty of room to back down—recognizing that there are lots of “ter­rific” immi­grants, as well as the “very bad” ones. More­over, states and cities have already taken an aggres­sive posi­tion to resist the enforce­ment of mas­sive depor­ta­tions of use­fully employed immi­grants that have already been hap­pen­ing under the Obama administration.

Trade is less clear with respect to the con­straints on the new President’s behav­ior. Pres­i­dents have unusual author­ity to slap puni­tive tar­iffs or bans on imports. The prin­ci­pal obsta­cle to doing this is the havoc it would play with Amer­i­can com­pa­nies and Amer­i­can jobs. Many things “made in Amer­ica” are made with com­po­nents which are man­u­fac­tured out­side the U.S. And more than half of all the goods Amer­ica imports from China are actu­ally made in China entirely by Amer­i­can com­pa­nies or by their part­ner­ships with Chi­nese coun­ter­parts. Sud­den puni­tive tar­iffs or embar­goes would leave Amer­i­can work­ers, con­sumers, and busi­nesses howl­ing in anger.

In the short run, dis­rup­tions of trade between Amer­ica and other coun­tries would have sub­stan­tial neg­a­tive eco­nomic effects in both the United States and its trade part­ners. If the dis­rup­tions con­tin­ued, the long-​run impact would likely be worst for the U.S. and its imme­di­ate neigh­bors, while other coun­tries, most notably China, could end up accel­er­at­ing their grow­ing shares of world trade and inter­na­tional invest­ment. An anti-​trade pol­icy that effec­tively leaves China to the Chi­nese and Amer­ica to the Amer­i­cans would only accel­er­ate the rates at which the U.S. is declin­ing and China advanc­ing. It is also quite pos­si­ble that con­tin­ued strength in the dol­lar ver­sus other cur­ren­cies could cause severe eco­nomic prob­lems in emerg­ing mar­kets and else­where, as hap­pened in the late 1990s and sev­eral times in the 1980s.

The Afford­able Care Act, or Oba­macare, has been the obses­sively hated demon of the Tea Party and most of the Repub­li­can Party since it was first pro­posed. But early sig­nals, includ­ing Trump’s com­ments after his ini­tial and only meet­ing with Pres­i­dent Obama, and state­ments from numer­ous Repub­li­cans, sug­gest that out­right repeal is now cor­rectly per­ceived as a low prob­a­bil­ity event. Oba­macare has gen­er­ally pre­served the uniquely expen­sive Amer­i­can way of pro­vid­ing health­care, with government-​protected monop­o­lies and sub­si­dies for drug– and med­ical device–makers. It appears that the new Con­gress will “repeal” most of the Afford­able Care Act but with a delayed effec­tive date, by which time a new sys­tem will have to be in place. Given the over­whelm­ing evi­dence on what has and has not worked here and else­where, as well as the cur­rent sen­si­tiv­ity of pub­lic opin­ion to the arro­gantly uti­lized monop­oly pric­ing power of drug com­pa­nies, it is con­ceiv­able that the new Repub­li­can health­care plan could be an improvement.

The other tar­get at which Repub­li­cans love to throw darts is the Dodd-​Frank Act, which set out to reform the U.S. finan­cial indus­try and restrict preda­tory behav­ior toward bor­row­ers, depos­i­tors, and investors. How­ever, the final prod­uct incor­po­rates many of the prob­lems it was intended to solve, par­tic­u­larly the com­plex and obscure account­ing stan­dards that have enabled banks and insur­ance com­pa­nies to out­smart reg­u­la­tors and investors. Most of the prob­lems of the finan­cial cri­sis in 2008 had to do with the impen­e­tra­bly con­fus­ing com­plex­ity of new finan­cial instru­ments that seemed to be designed for the sole pur­pose of facil­i­tat­ing fraud. There is con­sid­er­able sen­ti­ment among rank­ing Repub­li­cans on the rel­e­vant Con­gres­sional com­mit­tees, along with many other con­ser­v­a­tive thinkers, to replace this com­plex­ity with a sin­gle and sim­ple mea­sure of risk. An equally sim­ple pro­posal from the same quar­ters would impose a steep pro­gres­sive tax on the total assets of finan­cial insti­tu­tions, encour­ag­ing them to vol­un­tar­ily split them­selves up and dis­cour­ag­ing oth­ers from grow­ing too large, hence poten­tially end­ing the “too big to fail” black­mail under which banks grow and profit only to be bailed out by tax­pay­ers when they ulti­mately fail. All the same, pro­tec­tion for ordi­nary con­sumers from finan­cial ser­vices fraud is likely to be severely reduced.

It is also at least pos­si­ble, based on Trump’s rhetoric and the Repub­li­can plat­form, that anti-​trust pol­icy could be brought back from the dead. Amer­i­can cor­po­ra­tions and their inter­na­tional coun­ter­parts have been on a merger binge for nearly fifty years, result­ing in the growth of oli­gop­oly and monop­oly pric­ing power in almost every indus­try, from air­lines to drug stores to phar­ma­ceu­ti­cals to broad­cast­ing. If a change in pol­icy goes beyond help­ing his friends and pun­ish­ing his ene­mies, this could be a very pos­i­tive fea­ture of Trump’s administration.

Broad eco­nomic pol­icy is likely to be more active and sup­port­ive of growth since one party now con­trols the White House, Con­gress and, don’t for­get, the Supreme Court. Much of the stim­u­lus, in the form of renewed tax cuts for the high­est income earn­ers, will be morally and socially repug­nant and will have very lim­ited pos­i­tive impact on the broad econ­omy. But there is a long his­tory of sup­port among con­ser­v­a­tives for var­i­ous tax arrange­ments that ben­e­fit the work­ing poor, such as earned income tax cred­its and neg­a­tive income taxes that are likely to appear in the final Repub­li­can tax pack­age. More­over, increased infra­struc­ture spend­ing is a likely com­po­nent of increased fis­cal stim­u­lus and a con­se­quence of one-​party rule in Wash­ing­ton. This is both ben­e­fi­cial to lower income work­ers and an effec­tive eco­nomic stim­u­lus in the present, as well as a source of stronger growth in the future.

An increase in the fed­eral min­i­mum wage will almost cer­tainly remain, as it has been, on hold. But this is yet another area where recent progress has come pri­mar­ily from states and cities, which are likely to con­tinue reflect­ing wide­spread voter con­cern about the huge con­trast in the incomes of rich and poor Americans.

War is Hell

We have not yet jour­neyed through all nine cir­cles of Dante’s Hell, includ­ing the assaults on civil rights of every kind; how­ever, not to try your patience fur­ther, we can con­clude with war, which in the words of Gen­eral Sher­man, is hell itself. As in the mid-​1930s, much of the world is already engulfed in active war­fare. And, also as in the 1930s, many aggres­sions and atroc­i­ties have met lit­tle coun­ter­vail­ing force—from the American-​backed assault by Saudi Ara­bia on Yemen, to Russia’s seizures of por­tions of Geor­gia and Ukraine, to the free-​for-​all incur­sions in the Syr­ian civil war by many coun­tries includ­ing the U.S. and Rus­sia. Trump’s and Putin’s mutual admi­ra­tion is a wild card in the esca­la­tion of vio­lence in Ukraine and beyond. If Putin per­ceives Trump as naïve and inex­pe­ri­enced, that might encour­age fur­ther blood­shed. If he sees him as irra­tional and impul­sive, that might be a deter­rent to any provo­ca­tion. If he sees him as some­one who is will­ing to respect Rus­sia, that might put at least a tem­po­rary end to Russ­ian ter­ri­to­r­ial aggres­sion. Given that we sim­ply do not know the answers to these ques­tions, the risk of con­tin­ued expan­sion of wars and inva­sions has to be con­sid­ered high.

What about stocks and bonds?

Bar­ring some inter­ven­ing calamity, of which there are sev­eral plau­si­ble vari­eties, we are likely to see more fis­cal stim­u­lus (higher spend­ing and lower taxes), infra­struc­ture invest­ment, pos­si­ble moves to widen access to higher edu­ca­tion and other steps likely to add momen­tum to an econ­omy that is well into either a long (but slow) recov­ery or the late stages of a post-​recession rebound. Since unem­ploy­ment is already low and wages are already ris­ing, eco­nomic growth is likely to be mod­estly higher this year than in the recent past, with infla­tion likely to get back up to the Fed­eral Reserve Bank’s two per­cent tar­get, but not much higher. Cor­po­rate pric­ing power and profit mar­gins are likely to remain under pres­sure from gov­ern­ment actions, ris­ing labor costs, and excess capacity.

With inter­est rates still lower than stock div­i­dend yields and bond prices likely to fall as inter­est rates rise slowly in future years, stocks remain the invest­ment of choice, albeit with increased risks due to higher val­u­a­tions. In these cir­cum­stances, it seems wise to keep the major­ity of stock invest­ments in the U.S., though to a lesser extent than we have been. Invest­ments in the U.S. remain safer than almost any­where else, even if it is riskier than it has been in the recent past. But given the increased chance of an economic/​financial mar­ket set­back that is cen­tered in the U.S. with much less impact in other parts of the world, it also seems pru­dent to decrease some­what our present hold­ings of U.S. stocks, par­tic­u­larly in health care com­pa­nies, and to add to hold­ings in Europe, Japan, and to a lesser extent emerg­ing markets.

Robert has been a leader in socially respon­si­ble invest­ing since his pio­neer­ing work in SRI forty six years ago. He is cur­rently Chair­man of Zevin Asset Man­age­ment and has held var­i­ous senior posi­tions at the for­mer United States Trust Com­pany of Boston. In the 1960s Robert was also a pio­neer in the use of Mod­ern Port­fo­lio The­ory and com­puter tech­nol­ogy applied to invest­ment deci­sion making.