A new administration and evolving global trade relationships promise significant changes for most industries and markets, yet against this shifting backdrop an accommodative credit environment should continue for the foreseeable future.
The U.S. Presidential election was extraordinary for a number of reasons, but what was perhaps most notable were the shortcomings of all the predictive models whose forecasts wildly missed their marks. It wasn’t just the Beltway pundits who were proven so wrong; stock market analysts were equally off target, as prophecies for a market selloff in the event of a Republican win – pegged to range from 5% to 6% -- never did materialize. In fact, as we have seen, quite the opposite has occurred, as the ensuing rally has been ascribed to the “Trump effect.” What the latter predictions failed to account for was the fact that while uncertainties remain and will continue to mount, the return of a Republican administration to the White House should be viewed as a positive for capital formation. In fact, as most lenders and borrowers now realize, Donald Trump’s win will likely extend the credit cycle well into 2017 and beyond.
This is not to say the election results won’t have a considerable impact across industries and markets. Indeed, many throughout corporate America are bracing for considerable change over the next 12 months. It’s just that the net effect will likely bode well for the capital markets as Washington transitions to a core domestic policy that potentially marries the stimulus of the Obama administration with a pro-business agenda one might expect from a real estate developer-turned-president.
At a very high level, it can be expected that interest rates will rise, taxes will decrease, Federal spending will escalate, driving the deficit higher, inflation will raise its hand, and reform will occur across the regulatory landscape. The Affordable Care Act and Dodd Frank, for instance, are just two areas that will receive promised scrutiny. And the new “protectionist” ethos that characterizes the incoming Trump administration will almost certainly lead to higher import prices. Much of the forthcoming change, however, won’t necessarily translate into a weaker economic picture in 2017. If the credit markets were already entering the eighth or ninth inning of its current cycle at this time last year, the upheaval in Washington will actually serve to prolong the game by a couple of innings.
Dealmakers of all stripes, for instance, were likely applauding Donald Trump’s choices for his Treasury and Commerce Secretaries, Steven Mnuchin and Wilbur Ross, respectively. The pair, beyond boasting long track records in banking and private equity, have outlined an economic strategy that will lean heavily on tax reform and will be premised upon empowering the capital markets. In their first public appearance following the appointments, Mnuchin told CNBC’s Andrew Ross Sorkin that as it relates to assessing Dodd-Frank, “The No. 1 priority is going to be making sure that banks lend.”
This sets the tone for what is expected to be a business-friendly policy in Washington for the next four years. But in addition to taking a fresh look at existing regulations, the most significant catalyst could be the administration’s efforts around tax reform and, more precisely, its attempt to reach a stated goal of cutting corporate taxes to 15 percent. Whether or not the administration can actually reach such an ambitious target remains to be seen, but in the near term, Donald Trump’s tax repatriation plan would provide an almost immediate boost to M&A through enacting a one-time tax holiday for some $2.6 trillion in funds held overseas by domestic companies. Doing so, could likely have a significant effect on the overall U.S. economy by putting that capital to work in mergers and acquisitions, research and development, capital expenditures and stock repurchases.
Even as the election cleared up the biggest uncertainty heading into last year, the outcome created many new questions that will surely affect a number of industries and markets. Clean energy, to name one, will likely face growing pains as Donald Trump has pledged to re-allocate billions in federal funding that went toward climate change research and spending. Moreover, his selection of Thomas Pyle to oversee the Energy Department’s transition team foreshadows a coming “about face” from the White House as it relates to rolling back energy and environmental policies put in place or extended by the Obama administration. As the head of the American Energy Alliance, a public policy organization, Pyle has been an outspoken critic of carbon tax initiatives, solar-energy investments and subsidies for wind energy production, and has advocated for lowering barriers when it comes to developing shale energy, oil, natural gas and coal.
Hospitals and healthcare providers also confront a far more uncertain future under President Trump. The Affordable Care Act provided a boon for healthcare providers over the past few years through reducing the uninsured population by some 16.4 million people. Campaign threats to either outright repeal ACA or even strike components of the law, such as the individual mandate, would force hospitals to reassess their strategies for growth. The selection of Congressman Tom Price as the Health and Human Services Secretary would seem to confirm that the new administration intends to see through Trump’s campaign pledges, as Price has been one of the more vocal opponents against ACA. As a Congressman, he introduced legislation aimed at replacing Obamacare and his proposal took direct aim at the Medicaid expansion initiative, which is a core component of the Affordable Care Act.
While clean energy and healthcare providers face the biggest threats into 2017, other sectors will also face headwinds, whether it’s due to the change in administration, structural changes to the economy, pre-existing trends hitting critical mass, or evolving global trade policies. Companies in the media sector, for instance, will continue to struggle as advertisers continue to move their marketing spend to a more expansive digital universe. Emerging market companies will be more exposed to the rising dollar as the U.S. transitions to a rising rate environment. And even the firearms and ammunition industry will have to adjust in the short term, as upticks in gun purchases are typically driven by legislative threats that are now unlikely under a Republican administration.
Large global conglomerates are also navigating new waters as Britain is expected to enact its European exit clause in the first half of 2017, while populist movements in Italy and other countries within the EU continue to gain traction. Even at this early stage, these shifting dynamics have caused headaches for many global companies. This past October, for instance, food manufacturer Unilever and supermarket giant Tesco locked horns over a 10% increase in wholesale prices spurred by the precipitous drop in the value of the British pound. These are the unintended consequences of protectionist policies, and many large U.S. companies with significant overseas sales – faced with a strong dollar – will continue to be challenged. Should Donald Trump follow through on campaign pledges to bring WTO cases against China or raise tariffs, global commerce will only become that much more complicated.
Still, for every industry and market that faces headwinds following the election, there are others that will benefit from the tailwind created by the new administration. Take the pharmaceuticals sector: while Donald Trump has come out against the kind of tax inversions that were so popular among drug companies over the past five years, a Trump White House represents a far easier path for the industry than had Hillary Clinton won the election. The drug industry is also optimistic about the ramifications of Donald Trump’s promise to reform the Food and Drug Administration and focus on the need for “new and innovative” medical products. Many observers have taken this to mean that he will seek to ease regulations and eliminate hurdles in getting new treatments to market and possibly even end talk of price limits.
Closer to home, the financials sector also stands to benefit in 2017, again bolstered by a theme of de-regulation. As part of his campaign, Donald Trump pledged to dismantle Dodd-Frank. At the very least, though, many are speculating that his win will serve to defang the Consumer Financial Protection Bureau and the Financial Stability Oversight Committee within the Dodd Frank umbrella. Under President Trump the possibility also exists that the administration will either delay or do away with the Department of Labor’s Fiduciary Rule, a prospect that would benefit both asset managers and brokers.
Other winners would likely include traditional energy companies, particularly those with exposure to shale, oil and natural gas. The struggling coal industry should also get a shot in the arm with potential tax breaks as well as a relaxed regulatory landscape should President Trump succeed in scrapping the previous administration’s Clean Energy Plan. Infrastructure investments in transportation, clean water, the electricity grid, telecom and security would also support the materials and manufacturing sectors, while military spending appears set to rise in 2017, given policy positions aimed at repealing the defense sequester and creating a state-of-the-art “cyber defense and offense” system.
Assessing The Debt Landscape
To be sure there will be distinct winners and losers that emerge in 2017, although in many cases it won’t necessarily be mutually exclusive. As it relates specifically to the debt markets, for instance, the conventional wisdom might assume that revisions to Dodd Frank that benefit the banks will come at the expense of the burgeoning private debt market.
This is due to several factors. The number of community banks, for instance, has shrunk by over 40% since the mid 1990s, with the consolidation only accelerating after the financial crisis. Community banks also overwhelmingly focus on agricultural finance, residential mortgages and small business loans – areas where they may have a distinct advantage in terms of the local knowledge and awareness needed for underwriting. Private debt, in contrast, is primarily a transaction-driven market, with demand fueled by M&A, private equity and growth capital investments. While moves to revise Dodd Frank may mitigate complexity and ease compliance burdens for banks, it would be unlikely to translate into a materially larger risk appetite for these depository institutions. Moreover, any revisions to the law will most certainly not affect leveraged lending guidelines, which were put in place by the Federal Reserve and other regulators to combat “systemic risk” in the financial system. In a deal environment in which enterprise values and purchase prices in the small and middle market are ranging from 8x to 12x EBITDA, the numbers rarely work for buyers if the purchase price is comprised of 75% equity.
So despite all of the moving pieces that come with a new administration and the likelihood for significant shifts in policy that will influence the fortunes of specific sectors, for most lenders, 2017 will seem very similar to last year. Private equity, according to PitchBook Data’s most recent overhang report, had nearly $750 billion in available dry powder, which should drive PE activity for the foreseeable future. Strategic M&A, which remained robust last year, could even accelerate assuming Trump’s tax repatriation plan moves forward. Even if interest rates inch higher, expectations for moderate GDP growth and an improving corporate default rate should set the stage for another solid year in the small- and middle market. This kind of optimism alone puts the market in a better position than at this point last year.
Those of us that play in middle market finance should be prepared for a busy and interesting 2017.