Previous posts in this blog series have discussed some of the potential impacts of pending fiscal policy measures including tax reform and infrastructure spending. This final post will look at what deregulation may mean for businesses and the economy.
Supporters of deregulation believe that efforts to roll back existing rules will make the business environment more friendly and lead to better earnings, economic growth and ultimately more jobs. Opponents are concerned that deregulation will cause asset bubbles, expose people to fraud, and could damage the environment.
Since his inauguration, President Trump has already signed several executive orders (EO) aimed at severely cutting the number of federal regulations. One of them is an EO that requires the removal of two existing regulations for every new one that is enacted. While this order was aimed at a general reduction in the regulatory burden across the entire economy, other orders have been more specific to individual sectors including finance, energy, healthcare and homebuilding.
One of the easiest ways to deregulate is to suspend the effective date on orders from prior administrations if they have not yet gone into effect. President Trump did this with a Department of Labor rule that would have required all investment advisors to act in the best interest of their clients as a fiduciary (APCM is already a fiduciary to all of its clients!).
However, the President does not have complete and unilateral power to regulate or deregulate. Removal of existing rules may require congressional or judicial involvement and can take quite some time. The President has stated he would like to eliminate or revamp the Dodd-Frank act, which is the banking reform measures enacted after the financial crisis, however doing so would require action by congress.
The motivation for rolling back the number of regulations is the belief that that a high number of regulations increases the cost of compliance and creates a drag on the economy. Regulatory cost benefit assessment is difficult, so some data is focused on more indirect measures. One of these is the Federal Register (a log of all government agency rules, proposals, and public notices) which has averaged about 75,000 new pages per year for more than a decade.
Other research groups have more directly quantified costs. A recent study by The Competitive Enterprise Institute cited annual regulatory costs of $1.9 trillion. Another study by Mercatus Center at George Mason University uses an economic model that examines regulation’s effect on firms’ investment choices. The study found that by distorting the investment choices that lead to innovation there has been a considerable drag on the economy, amounting to an average reduction in annual US GDP growth of 0.8 percent.
While the political nature of deregulation can be controversial, the market has interpreted that the planned fiscal policies of the new administration are signaling a shift to a more pro-business climate. Measures of sentiment have improved since the election and this is evident in survey data such as the spike in the small business optimism index that occurred after the election.
Many believe Trump has unleashed “animal spirits” which is a term coined by economist John Maynard Keynes to describe human emotions that influence behavior and in turn lead to action, in particular investment and economic activity. Animal spirits can be powerful and should not be ignored. In his annual letter to shareholders, BlackRock CEO Larry Fink shared the following chart to illustrate the correlation between sentiment and the stock market.
APCM will be monitoring how the improved measures of sentiment impact future consumer and corporate spending as consumption is an important part of US economic growth and earnings potential. Additional earnings growth is essential to the outlook for the equity markets given today’s prices.
The investment team at APCM expects the reflationary fiscal policies highlighted in this series to put upward pressure on growth, inflation and interest rates. If these measures translate into an acceleration of economic growth and better earnings, then the eight-year bull market run in stocks should continue. We anticipate a cyclical (near term) bounce above the recent 2% GDP growth trend, but a return to the historical 3% average is unlikely. We haven’t changed our longer-term outlook for the continuation of modest economic growth because it is still too soon to tell if fiscal policy will be powerful enough to overcome unfavorable demographics and increasing debt levels.
I hope you have found these policy posts helpful!
Brandy Niclai, CFA®
Chief Investment Officer