The US stock market’s shifting reaction to the inability of Donald Trump and the House of Representatives to repeal Obamacare belies the much bigger question the failure raises for Wall Street: can this administration steer corporate tax cuts through Congress?
This matters because the expectation that American companies will enjoy smaller tax bills has helped fan a 10 per cent gain for the S&P 500 since the election and a 13.3 per cent advance for the Russell 2000, home to the smaller businesses that are judged to be the biggest beneficiaries of any cuts.
Early signs on Monday suggest a degree of nervousness. Asian and European equities are weaker, the dollar is close to erasing its post-election rally and US equity futures are down. Mr Trump was quick to dismiss the idea that an ignominious retreat on healthcare casts a shadow over the prospect for tax cuts.
“I would say that we will probably start going very, very strongly for the big tax cuts and tax reform,” Mr Trump told reporters. “That will be next.”
However, analysts say it is hard to escape the conclusion that the failure of the White House and Paul Ryan, the speaker of the House, to build the necessary consensus on healthcare legislation deflates some of the optimism over the chances of the swift passage for an economic stimulus package.
“The hope and hype that came in the first few weeks after the election didn’t seem to meet the ready cynicism about campaign promises not translating to active policy,” notes David Ader, chief macro strategist for Informa Financial Intelligence. “Now as political gaming comes into play, the hype faces challenges.”
After the House vote on healthcare was pulled shortly before the US stock market closed on Friday, Steven Mnuchin, US Treasury secretary, insisted tax reform would prove far simpler than tackling the politically vexed issue of healthcare.
That view has some support from strategists at Goldman Sachs who argue the debacle over healthcare has not really changed anything. “Ultimately, we believe that there will be broad support among Republicans in Congress for legislation that reduces the corporate tax rate and cuts personal taxes modestly,” notes Alec Phillips of the bank, which puts the chances of a significant cut in corporate tax rates at 80 per cent.
Mr Ryan described on Friday the “growing pains” Republicans faced moving from a party of opposition to one of government, and many are anxious they will surface again when tax moves to the top of the legislative agenda.
Jan Loeys, a strategist at JPMorgan, points out that many Republicans are still allergic to large budget deficits that would result from a tax overhaul without the savings that were expected to be generated from changes to healthcare.
“We ourselves also do not expect much, mostly as it is hard for the Republican party to marry its desire for tax reform with its aversion to large fiscal deficits,” he argues. “That does not mean it is game over for tax reform, but simply that it may take several years.”
While Wall St analysts have not factored corporate tax cuts into their 2017 forecasts for the S&P 500, most have begun pencilling them into estimates for next year. Indeed, a reduction in the US corporate tax rate from 35 per cent to 20 per cent would, according to a study from Barclays, lift the earnings per share of S&P 500 companies by 12 per cent.
Scrutiny of the consensus-building skills of Mr Trump and Mr Ryan comes at a delicate juncture for the post-election rally. The longest run of trading days without a 1 per cent decline in the S&P 500 in more than two decades ended on Tuesday, when nervousness over the broader implications of healthcare first flared. Deutsche Bank analysts note that the stock market had been as calm only twice in the past 20 years. When it last happened in early 2007 and the middle of 2014 it augured badly for equities.
For now, investors are likely to play a waiting game before they can properly judge what the healthcare imbroglio means for those parts of the Trump agenda they covet most.
“This concern will undoubtedly be with us for the foreseeable future, or at least until we get a better sense of how Trump will navigate the political roadblocks that he is now encountering,” says Ian Lyngen, an analyst at BMO.
What is clear is that investors will have to parse intramural Republican politics with the same intensity that they usually bring to to bear on Federal Reserve speeches and statements.