This week investors have been getting concerned about presidents, reform and corruption.
Most obviously, there is the ongoing saga of President Trump and his fractious relationship with former FBI Director James Comey.
Mr Comey has the unfortunate distinction of being only the second ever Director of the FBI to be sacked. Comey’s removal – initially explained as being over his handling of an investigation into Hillary Clinton – took on greater significance as the week progressed.
President Trump is alleged to have asked Comey to drop an FBI investigation into former National Security Adviser Michael Flynn’s links to Russia. Lawyers may ultimately have to decide whether this would amount to obstructing justice and there have been plenty of calls for - or suggesting the potential for - impeachment.
On Wednesday, the S&P 500 US market fell back from its record high and the dollar weakened too.
Meanwhile, on Thursday, Brazil’s financial markets plunged 10% following claims that President Temer had approved a bribe to prevent a former parliamentary speaker testifying in Brazil’s ongoing anti-corruption probe. Temer, it should be remembered, succeeded former President Dilma Rousseff after her removal on corruption charges.
Why are investors worried?
What is important to investors is policies not personalities.
In the US, it is not who occupies the Oval Office but what might happen while they are there.
Although we have been fairly sceptical of the faddish “Trump trade” there remains hope among some investors that the President will pass a huge tax cut later in the year. Optimism of this kind was far greater earlier this year but has gradually drained away as the President and the Republicans have really struggled to pass material pieces of legislation.
Similarly in Brazil, a repeat of the lengthy impeachment process which engulfed ex-President Rousseff would delay much-needed labour reforms and raising the retirement age from its current early 50s.
How important are the US tax reforms?
We are far from convinced that the tax cuts proposed by President Trump would be of serious benefit to the US economy.
While there is a good case for reducing the corporate tax rate, the Trump administration seems to be determined to couple this with tax cuts that seem targeted at the wealthy. Much of those cuts would likely be saved by the recipients, rather than providing stimulus for the economy. As a result, America’s public finances, which are due to deteriorate anyway, would be even worse, and this would occur towards the end of the economic cycle when traditionally governments should be shoring up their finances against an eventual recession. And, to the extent that tax cuts could boost demand, they would do so when demand seems to be picking up quite naturally, potentially hastening the onset of inflation and recession.
Will President Trump be impeached?
He could be, but that in itself is unlikely to worry the market. The most likely time would be late next year, though for now the Republicans control the House of Representatives which is where an impeachment vote would have to be passed.
There is a good chance of the Democrats taking control of the House in November 2018, if only because presidents with low approval ratings have historically lost a lot of seats during the mid-terms after that president’s election. Impeachment, however, matters very little unless the Senate subsequently votes by two-thirds majority to remove the president from office.
The only circumstance in which that is likely to happen would be if there was incontrovertible evidence of wrongdoing because otherwise, regardless of who is in majority, Senate Republicans are likely to give the President the benefit of any doubt.
What would happen if Trump were to leave office?
The US has a line of succession and you can go quite some way down it before you find a candidate who would upset the markets. Vice President Mike Pence would be first in line. He seems to have been taking a larger role in the Trump administration than vice presidents traditionally have, perhaps because of the President’s unorthodox style and lack of political experience.
If for any reason he was not prepared or able to serve, then the Speaker of the House of Representatives would take over. Speaker Paul Ryan is the author of his own more coherent package of tax reforms, so we can assume that at least some parts of the market would be buoyed by such a development.
Of course under such circumstances the chances would still be that the window of opportunity for tax reform in 2017 might have been lost due to the time taken for the administration to collapse. But generally we tend to think that investing in the hope that politicians will do great things is a strategy at risk of disappointment.
Far better to invest where the private sector works efficiently, institutions are strong and politicians are unable to do too much damage. For all its challenges, the USA seems to be proving just that.
By Guy Foster, Head of Research
Guy leads Brewin Dolphin’s Research team ensuring that a rigorous and exhaustive investment process is employed. He also provides recommendations on tactical investment strategy to Brewin Dolphin’s investment managers and strategic recommendations to the group’s Asset Allocation Committee. Before joining Brewin Dolphin in 2006, Guy was an Investment Director at Hill Martin (Asset Management). Guy has a Masters in Finance from London Business School. He is also a CFA charterholder, holds the CISI Diploma, and is a member of the Society of Business Economists. Guy frequently discusses financial issues with the written and televised media as well as presenting to the staff and clients of Brewin Dolphin.
The opinions expressed in this document are not necessarily the views held throughout Brewin Dolphin Ltd.
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