POTUS 45: The implications of regulatory reform

Our fourth report in a series of six entitled "POTUS 45: The implications of regulatory reform” explores how certain sectors—particularly financials, healthcare and energy—could be impacted by policy changes and outlines where the most compelling investment opportunities will lie.

Key takeaways

Financials—It is estimated that the largest banks have as much as $130 billion of excess capital that could be unlocked by regulatory reform. Capital could be redeployed through stock buybacks, dividends or investment in growth.

Healthcare—While bringing mixed results, the repeal of Obamacare would be mostly positive for insurance companies. Insurers are expected to have more flexibility over product offerings and pricing as well as benefit from potentially lower taxes.

Energy—By reducing the regulatory burden across the board, we expect ongoing growth of production across all sources of energy including oil, gas, wind and solar. Companies in long haul oil and natural gas pipelines are likely to benefit most in the short term.

A businessman in the White House

Donald Trump is no stranger to being in charge. But his elevation to president of the most powerful country in the world will test his leadership capabilities in a completely new domain. Trump is the first US president in history to come from an exclusively private sector background. During the campaign, candidate Trump used his political inexperience to his advantage, winning over disgruntled voters with his unfiltered, unconventional rhetoric and vows to run the country like it were a business. He appealed to the interests of American business owners, with promises to eliminate red tape and create a friendlier environment for homegrown companies to prosper.

So far, President Trump has remained on point in this regard by making regulatory reform a top priority. While the process of implementing this reform will be fraught with political obstacles, it is clear, no matter what form the ultimate regulatory relief takes, that corporate America will be operating under a new set of rules. Certain sectors of the economy – namely, energy, financial services, and healthcare – will be disproportionately affected by these policy changes, giving rise to important investment implications.

A tall order

Almost immediately after taking office, President Trump took action on changing the rulebook for US businesses. On the day of his inauguration, the new president released an executive order focused on reducing the economic and regulatory burdens of the Patient Protection and Affordable Care Act (the ACA or Obamacare). Days later, he issued memoranda paving the way for continued construction of the Keystone XL and Dakota Access pipeline projects. And by the end of his first two weeks, he had ordered a review of financial regulation, including the Department of Labor’s hotly debated Fiduciary Rule. Trump also ordered an overall reduction in regulatory burdens and costs, which included his two-for-one rule requiring the identification of two prior regulations for elimination for each new regulation issued. Finally, Trump targeted several environment-related regulations that he believes impose undue restrictions on businesses; he ordered a review of the Environmental Protection Agency’s Clean Water Rule and is widely expected to issue a similar order concerning President Obama’s Clean Power Plan.

Enacting changes

The Trump administration is making headlines with these orders, but it’s important to discern the extent of change possible within the purview of presidential power. While the executive orders have set the course for potential reform, the next stage in carrying out this agenda will require new legislation, and, potentially, the selective defunding of government agencies. Both of these steps require congressional support – the president cannot single-handedly change the law. In the case of financial and healthcare reform, a supermajority vote (e.g., a 60-seat filibuster-proof majority in the Senate) would be required for a full repeal of the Obama-era laws (i.e., the ACA and the Dodd-Frank Act, the post-crisis financial services reform law). Instead, Trump and congressional Republicans will aim to shift the interpretation, implementation, and enforcement of these laws through a combination of targeted legislative action – using the budget reconciliation process that requires only a simple majority – and issuing a series of executive actions. Even with this combination of approaches, vestiges of the ACA might survive the Republicans’ healthcare replacement plan for some time. We also expect some post-crisis financial regulations to remain in place.

It is important to keep in mind that Trump is not the only person driving this agenda. The president has surrounded himself with a cabinet that generally shares his private sector background. With critical seats filled by former CEOs and bankers, we can expect a different tone from Washington. Trump’s picks to head key government agencies also could alter the regulatory landscape. For example, the appointment of conservative-leaning Ajit Pai as chair of the Federal Communications Commission could weaken the enforcement of net neutrality that calls for equal treatment of all lawful internet traffic. Also, the nomination of Scott Gottlieb – a conservative physician with ties to the pharmaceutical industry – to head the Food and Drug Administration could have implications for new drug approvals. Finally, Trump has support from a Republican majority Congress, which can use the Congressional Review Act – an obscure, rarely used law – to overturn some regulations issued in the final days of the Obama Administration.

Making America great again?

A pro-business posture in Washington is likely to be positive for the corporate sector. In the short term, we have seen a revival of so-called “animal spirits” spawned from optimism around potential tax reform and regulatory relief. Small business confidence has surged after the election. The National Federation of Independent Business’s Small Business Optimism Survey experienced its largest monthly gain in over 30 years in December – and the percentage of companies that cited government requirements and red tape as their number one problem dropped to 15% from an average of 21% during Obama’s second term. The question now is whether this confidence boost can be sustained long enough to lead to actual economic growth. The answer lies in whether the Trump administration can execute on its reform agenda. If business confidence remains strong, we could expect to see a pickup in business spending from current lackluster growth rates. In our view, this will be one of the biggest levers for improved economic growth under the new administration.

We are obliged to note that the potential economic benefits of regulatory reform could be offset by restrictions on trade and immigration, which might exacerbate geopolitical tensions. We also need to consider the long-run economic costs of environmental and social damage that could result from a business-first approach.

Trumping expectations

The market reaction to Trump’s presidential victory has exceeded consensus expectations. Financial market pundits have been quick to dub the post-election market movement as the “Trump trade” or “deregulation rally,” but we caution against giving all of the credit to the election outcome. Economic momentum had been building over the last 12 months as energy investment spending bottomed out and emerging markets stabilized. This has been responsible for a fair portion of the market’s post-election gains, and sectors most tied to Trump’s policy proposals have had mixed results. For example, financials, which have enjoyed the strongest gains since the election, have been largely buoyed by higher interest rates. On the other hand, the energy sector has lagged, due to an oil market marred by skepticism around OPEC production cuts. Finally, in the healthcare sector, we have seen pressure on valuations amid ongoing uncertainty around the dismantling of Obamacare and the debate over drug pricing. So, while the market may be benefiting to some degree from the prospect for a more business-friendly landscape, we do not see market sentiment as out of sync with reality. In fact, we believe that in some sectors, the full benefits of potential regulatory reform are not yet priced in, creating attractive investment opportunities.

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UBS Wealth Management Research