In its quarterly Beige Book publication, Goldman conveniently gathers anecdotal evidence of fundamental and thematic trends from the earnings transcripts of companies in the S&P 500. As Goldman's Davis Kostin explains, since President Trump’s surprise victory over Hillary Clinton in November, investors and management teams have been acutely focused on the new administration’s policy proposals. In this Beige Book, we focus on management commentary regarding four key pillars of the Trump Administration’s agenda: tax reform, regulation, fiscal spending, and trade policy.
Here are the summary highlights:
- Tax reform: Managements are optimistic about potential n corporate tax reform, but are concerned about the controversial border-adjusted tax. Lower corporate taxes represents a potential tailwind to corporate earnings, but our US Economics team expects comprehensive tax reform may be delayed until late 2017 or early 2018. Selected examples: BBT, BXP, CAT, CB, CVX, JNJ, PFE, PNC, UPS, and UTX.
- Regulation: Hopes for widespread deregulation and improved regulatory clarity are increasing confidence among some management teams. Selected examples: BBT, BXP, CMCSA, COP, CVX, MA, MO, PAYX, PX, and T.
- Fiscal spending: Managers of industrial firms are enthusiastic about potential infrastructure spending and a possible end to the defense sequester. President Trump proposed a $1 trillion infrastructure plan in his presidential campaign, but we expect the actual spending package will be $25 billion per year. Selected examples: AEP, AET, DGX, FDX, JNJ, LMT, LUV, and PX.
- Trade policy: Management views are mixed on whether President Trump’s trade proposals will be constructive or will lead to damaging retaliation from US trade partners. Selected examples: CB, HON, MS, NKE, and PYPL.
The latest quarterly report contains excerpts from 39 companies that account for 18% of total S&P 500 revenues and 23% of the S&P 500 equity capitalization. All management comments on the following pages were taken verbatim from company transcripts as recorded by CallStreet and accessed via FactSet.
1. TAX REFORM
S&P 500 management teams are optimistic that corporate tax reform and a reduction in the statutory corporate tax rate will boost earnings and make US companies more competitive with international competitors. Investors and management teams have been analyzing key provisions of the GOP tax plan including a reduction in the statutory corporate tax rate, the controversial border-adjusted tax, repeal of net interest deductibility, full capital expensing, and a deemed repatriation of overseas earnings at a preferential tax rate. Our US Economics team believes tax reform is likely, but legislation may not pass until late 2017 or early 2018.
- Chevron Corporation (CVX): And we all know that our tax system is not competitive. We want American companies to be able to compete, and so there’s a lot of work being done to try to bring down corporate rates so that we can compete both at home and abroad for capital. And of course, the administration has a focus on bringing jobs and capital back to the U.S., and lower rates will help that. In my view, they’re looking for pay-fors. They’re looking for ways to make those lower rates happen. And so they’re looking at a variety of different concepts. And the truth is there are a lot of different ideas being floated right now. And I think they’re looking for input, and we’ll continue to provide it.
- BB&T Corporation (BBT): It will take a little while for it to get going, but look, we’re going to have lower taxes, less regulation. It’s really a big deal. Optimism is up, I’ve been talking a lot to clients, and to our RPs, regional presidents in the last several weeks, including yesterday, and clearly CEOs are optimistic, they’re making plans to invest, and we really think this is going to kick-in to a meaningful improvement in investment and job growth as we head into the second and third and fourth quarter.
- Pfizer Inc. (PFE): I’d like to point out that the most impactful thing with tax reform will be to level the playing field between U.S. companies and foreign companies in regards of the foreign companies not having the tax advantage of acquiring companies and then taking it to a low-tax location. So that’ll be a fundamental change in competitiveness. To the extent that tax changes would make it cheaper for us to access financing, then you’re quite right. Some deals that previously would not have been affordable, may now be affordable.
- United Technologies Corporation (UTX): Certainly, tax reform is the biggest single item that we’re focused on this year... Well, first of all, we’ve obviously been following the Trump administration closely in terms of what you’re talking about on tax reform. And it looks like we’re going to be following the Chairman Brady blueprint out of ways and means which would lower the top rate to somewhere around 20%, eliminate the deductibility of interest but also provide for immediate expensing of capital. Also provide for a territorial system which is really good news for us because, as you know, we’ve got about $6 billion in cash sitting overseas that we can bring back to the U.S. very cost effectively.
- Caterpillar Inc. (CAT): I think you can probably get your mind around the idea that the second half of the year probably has the most upside. All the things that we’ve talked about, tax reform, better economic growth. That’s certainly not impacting what’s on the books, getting produced and shipped here early in the year... So I think if there’s upside, it’ll probably come later in the year, particularly if we start seeing better economic growth, we get tax reform kind of nailed down so people actually know what’s coming. The more that happens, the sooner the better.
- Johnson & Johnson (JNJ): As both sides in the aisle in Washington have noted, the U.S. tax code for business is outdated and in many cases makes the U.S. a more costly place to do business, leaving U.S. workers and the U.S. economy at a disadvantage. We are very encouraged by the proposals currently in discussion and will support business tax policy that is competitive with most developed countries and encourages innovation and growth. This includes a system based on territorial taxation in line with most economically developed nations.
- Amgen Inc. (AMGN): [President Trump] talked, I think, publicly when we were with him about the need to look at areas of reform, tax reform, regulatory reform, intellectual property protection, trade policy. So all of those, I think, are encouraging for us.
Reduced statutory rate:
- BB&T Corporation (BBT): So right now, the corporate rate’s 35%. In essence, we get almost 90% of it for a given tax rate change. So tax rates fall from 35% to 15%. We would get close to 18% lower taxes on it. The reason we don’t get all of it is really driven by how our state taxes impact the change in the corporate tax rate. But we get the vast majority of it.
- U.S. Bancorp (USB): But to keep it simple, if we saw a tax – a corporate tax rate decline of 10%, we would expect our effective tax rate to benefit or go down by about half of that, or about 60% of that. So think about 5 percentage points to 6 percentage points in that range. That’s essentially what we would expect to see the change in our effective tax rate, and it’s because of the various dynamics associated with how tax credits work.
- General Electric Company (GE): And I think what GE wants, and what we think is most important competitiveness for U.S. companies, is essentially a competitive tax rate, something that looks more like the OECD average, which is roughly 21%, 22%, and this notion of territoriality that you pay the tax in the jurisdiction that you actually earn it. And then from there, those earnings are fungible and can move cross border. Quest Diagnostics Incorporated (DGX): With the majority of our taxable income earned in the United States, we could benefit from any material reduction in U.S. corporate tax rates. We would expect to use a portion of potential tax savings to invest in accelerating growth.
- FedEx Corporation (FDX): The bigger issue for all of you to look at longer term for us is the features that are in the GOP blueprint and President-elect Trump’s plans that we like a lot, and those include materially lowering the tax rate, the effective territorial treatment of foreign earnings, and current expensing of CapEx. We think that will positively impact our top line through stronger economic growth and, of course, the bottom line potentially in a very big way through the lower tax rate... But if you think about our tax rate this year in the 36% to 37% range, a 20% tax rate would be a mighty fine Christmas gift.
Border Adjustment tax:
- FedEx Corporation (FDX): ...We are concerned about the border adjustability concept and are trying to figure out how it would affect us directly, as well as our customers and trade and global growth, in general... This is just very destructive of trade. It’s not the proper solution to the problem. I think if they lower the tax rate and went to territorial, it would accomplish 95% of all the benefits they’re looking for and ignite a significant investment boom in the United States. It would solve the inversion problem.
- Pfizer Inc. (PFE): So regarding the connection between tax reform, manufacturing, and bringing jobs back, we are not – as an industry, we’re interested in highly qualified workforces that have been trained, and – but we’re driven by the tax code today to manufacture outside of the United States. If there is no penalty by the border adjustment for manufacturing inside the United States to supply your markets outside of the United States, that will encourage us to put more jobs in the United States... I think the Republican leadership has overall tax changes that are overall favorable for the pharmaceutical industry. Certainly would allow us to create more jobs in the United States. And I don’t really think that we would feel that the changes as being proposed are negative for our industry – far more positive, in fact.
- Delphi Automotive PLC (DLPH): I’ll give out some numbers. I’m happy to discuss numbers... this border tax adjustment is really not known at this point. I think there’s sort of three sentences in a 13-page document that is what a lot of people are keying off of. But round numbers, our cost of sales value for imported materials into the U.S. is about $4 billion. The majority of that is out of Mexico, about $3.5 billion, and we’ve talked about that back a couple of months ago when tariffs were sort of the topic of the day.
- Procter & Gamble Company (PG): That said, there’re a few facts that might be helpful. P&G produces 85% of the product that it sells in the U.S. domestically and we export about 10%. So a net import balance of only about 5% of U.S. sales. The majority of the small amount of imported product is produced in Canada. We estimate that over 90% of the materials we use to manufacture products in the U.S. are sourced domestically.
- ConocoPhillips (COP): I think a lot of uncertainty on the Border Adjustment Tax and its potential impact on how crude and other products move across the border, whether it’s south of Mexico or some of the crude that moves down from Canada into the U.S. I think there’s a little bit to be seen yet what that means. Does it get exempted or how are the details of that going to unfold?
- Chevron Corporation (CVX): President Trump has indicated that the border adjustment concept is complex, and I would agree with that. And so I think we need to take a close look at perhaps the consequences of that, both some that could be positive and the unintended consequences in terms of impact on consumers, exchange rates, and knock-on effects on the global economy. And I have no doubt that the administration will do a good job of doing that and will settle on the right kind of tax reform at the end of the day.
- Constellation Brands, Inc. (STZ): As you know, our imported Mexican brands can only be authentically produced in Mexico and sold in the U.S. In order to understand how different tax reform proposals could impact our business, we have modeled several different potential scenarios that include border adjustability, as well as some of the positive facets of a corporate tax reform plan based on what we know today... I’d also point out that the other benefits of tax reform that’s being suggested in the Better Way plan being put forth by the House, right, has very significant other benefits which will also offset any negative from border adjustability. So, I think it could be a net positive when all is said and done but it remains to be seen.
- United Parcel Service (UPS): When you get to the House blueprint, while we do appreciate the tax rate, we do share some concerns that many of our customers have about the potential impact of the border adjustment tax. And one of the first questions is we’re trying to find out just exactly how that’s going to work. And it’s a little bit early. We don’t have all the answers yet.
- Pfizer Inc. (PFE): In terms of the other part of your question about access to overseas cash, or easier access to overseas cash, clearly that would be beneficial. That would be favorable, all other things being equal. But in terms of does that make it easier to do deals? The answer is it depends. For example, what happens to the valuations of all the companies? If it’s easier to have access to overseas cash, does that drive valuations and prices up? So the compass has to continue to be shareholder value, return on capital, relative to our cost of capital. That’s what we’ve always done. That’s what we’ll continue to do. But at a macro level, all other things being equal, does easier access to our global cash help us, is it more favorable? The answer is yes. But there’s other factors that we’ll have to understand as we work our way through business development.
- Apple Inc. (AAPL): I am optimistic given what I’m hearing that there would likely be some sort of tax reform this year, and it does seem like there are people in both parties that would favor repatriation as a part of that. So I think that’s very good for the country and good for Apple. What we would do with it, let’s wait and see exactly what it is. But as I said before, we are always looking at acquisitions. We acquired 15 to 20 companies per year for the last four years. And we look for companies of all sizes, and there’s not a size that we would not do based on just the size of it. It’s more about the strategic value of it.
- PayPal Holdings Inc. (PYPL): If we’re allowed to repatriate funds from offshore in a more tax efficient manner, that might make a big difference in the way we think about capital allocation. And so we think that would be a big net positive. E. I. du Pont (DD): If we get the repatriation piece of that coming along with it, that would have very favorable impact... the biggest part of our cash on the balance sheet is outside of the U.S. and so that would have favorable impact on liberating additional dollars to be spent, whether it be on CapEx, M&A, or returning value to the shareholders through share buybacks or dividends.
- Halliburton Company (HAL): Of our $4 billion in cash, approximately half is offshore. We require about $1 billion to run the business. Given the strength of our cash position and the potential impact of U.S. tax reform, we’re actively evaluating our options and opportunities around uses of cash, which could include accelerating the maturity of debt, funding acquisitions and organic growth projects, or shareholder return opportunities.
- Honeywell International Inc. (HON): In the fourth quarter, we did about 2 million shares of buyback which is more than we normally would. And what I would say is that we’re going to continue on that approach. I mean, we do have a little bit of a restricter in terms of where our cash is located. You know that most of the cash is overseas, so we can’t just take $9 billion of our overseas cash and put it into buybacks, I mean, it’s not – just not practical.
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Management teams are hopeful that widespread deregulation and improved regulatory clarity will stimulate economic growth. In an effort to simplify the regulatory environment and reduce its burden on US companies, President Trump signed an executive order mandating that two regulations be eliminated for every new regulation added. Topically, the President has committed to dismantle Dodd-Frank and to investigate pharmaceutical pricing methods.
- AT&T Inc. (T): I had the opportunity to meet with what was then the President-elect a couple of weeks ago. And I got to tell you, I was impressed. I was meeting with a CEO. It was obvious. And the President had a very specific agenda in terms of what he thought was critical, and that was tax reform and regulatory reform. And we spoke at length about each of those. And I would tell you that the man, the President is focused on these. And so I left with a degree of optimism that this could actually be pulled off this year.
- Comcast Corporation (CMCSA): I think regulatory certainty for investors is the same as it is for management. It helps you have the confidence to make long-term plans. And the kind of discussion we’ve been having this morning, whether it’s fiber or other investments in in-home equipment, and what your business opportunities are, the more uncertainty, the less encouraging it is to want to invest. So we’re encouraged by the prospect of rules that we believe will encourage that investment, stimulate investment, whether that’s tax decreases or revisiting the authority of the government to go to places that they said they weren’t going to, but legally they could go to.
- Altria Group, Inc. (MO): Both at the FDA and for regulatory agencies, generally there appears to be a movement to try to lessen the regulatory burden on business. Our view that would be good. But those things take time to work their way through the agency. Take HHS for example. We don’t even have a cabinet appointee yet much less changes that would occur down the line.
- Chevron Corporation (CVX): In an overall sense, I’ve been very pleased with the agenda that the Trump administration has. We have seen an avalanche of regulation over the last decade, and putting a much more balanced cost/benefit framework in place to assess the value of those regulations, freeing up infrastructure pipelines, all of that is quite positive for our business, for the country, job creation, and a lot of things.
- ConocoPhillips (COP): Well I think it’s a little early to tell. We certainly hope the new administration, at least in terms of what they’ve talked about, is going to give us a little bit of regulatory relief, which is we think is good. There are some things that the last administration were proclamating that were a bit worrisome on sort of how it might slow the business down, both on the regulatory side and on the infrastructure side.
- Praxair, Inc. (PX): I don’t think less regulations is going to benefit us quite as much as it might our customers, for example, our energy customers who they would argue they’ve been saddled with some very difficult regulations over the year. So to the extent that that investment were to take off, we would certainly benefit from that.
- Boston Properties, Inc. (BXP): Now much has been speculated about a “Trump bump” to office markets in Washington, D.C. due to increased government activity, and New York City due to financial deregulation. While we see financial tenants more confident, as a result of the strong stock market in the fourth quarter, and legal and lobbying activity has increased in Washington, D.C., we believe it is too early to expect to experience broad positive leasing activity as a result of the speculated plans of the executive branch in Congress.
Dodd-Frank / financial regulation:
- JPMorgan Chase & Co (JPM): ...When you grow to add bankers or stuff, you know you have to do it through a cycle. I do think if there’s some regulatory relief, you will see banks be more aggressive and growing, opening branches in new cities, adding to loan portfolios, seeking out clients they don’t have. So I’m hoping that we’ll see a little bit of that too, but that will wait for a little regulatory relief.
- Bank of America Corporation (BAC): The optimism for positive change here at Bank of America and among our customers is palpable and has driven bank stock prices higher. We’ll have to see how these topics play out but that we are optimistic...
- U.S. Bancorp (USB): I understand, the administration that’s going to take office in the a few days, their number one issues are health care reform, taxes, and infrastructure. And somewhere in the top five might be financial services, but it’s not the top three. A lot of financial services issues, I think, will be dealt with in the early part of the year, but with some implications later.
- Johnson & Johnson (JNJ): We have maintained a responsible approach to pharmaceutical pricing, generally limiting aggregate annual price increases to single-digit percentages below those of our competitive set. Furthermore, in our pharmaceutical business, we invest more in R&D than we do in sales and marketing. And cumulatively since 2010, we’ve invested more incremental dollars in R&D than we have realized from U.S. net price increases... I think it’s incumbent upon us as an industry to price responsibly. As you heard in the comments that I made earlier, we have attempted to do that. We believe that that has in fact been our practice.
- Amgen Inc. (AMGN): And now on the topic of drug pricing, the President was also clear, as he was throughout his campaign, about the need for us to find ways to bring down the cost of drugs for citizens in the US. We want and expect to work with the President and the administration to be part of the solution in that effort. In participation with the administration and Congress, we will seek to advance changes that enable more Americans to have affordable access to life saving and cost effective medicines.
- Pfizer Inc. (PFE): So I think complexity of drug prices involve all of the other comments [President Trump] made. And I think there are lots of ways, like changing regulations to allow value-based contracting between the industry and the health system, will also be very helpful. We have a regulation that was created for fee-for-service, and now we need regulations in a new world of value-based pricing. So I think there’s lots of ways we can work with the administration to ensure that patients have affordable drugs – or more affordable drugs in the United States.
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III. Fiscal Spending
S&P 500 companies are optimistic about the prospect for increased government spending, particularly aerospace & defense and other industrial firms. A far cry from the $1 trillion infrastructure plan President Trump suggested during his campaign, our Washington, D.C. economist Alec Phillips expects only a modest spending package of $25 billion per year to be enacted as Congress focuses on other issues and is constrained by the size of the budget deficit.
- Praxair Inc. (PX): In terms of what might happen with infrastructure spending and things like that, nothing has really taken place yet. Some talk of energy investment, looks like that may happen, but again, nothing has happened yet... the U.S. is 40% of our sales. So anything positive that happens in the U.S. is going to benefit us and I would certainly hope that some of these things come to fruition. Again, I think infrastructure spending can be a big deal. It can certainly be a big deal to our customers and we would certainly benefit from that. But how much of that do you really think is going to be available? How much of that do you think is really shovel ready in 2017? So that kind of remains to be seen.
- Lockheed Martin Corporation (LMT): And I’m very encouraged that the dialogue has been around eliminating the defense sequester, just removing it altogether and there’s also a strong discussion around increasing defense spending, because we have, for the last few years, allowed our – with the budget caps et cetera, we have not been investing like we need to in recapitalization and in readiness and then a lot of things that you hear directly from our customers, our services telling Congress and telling the new administration that they need. So we’re very supportive of our defense customers and being a voice around that, because we do think it’s important to eliminate the sequester and the budget caps associated with it to allow them to do – to address the national security strategies and to provide the right capability for men and women in uniform.
- Caterpillar Inc. (CAT): For 2017, in reality, when we get towards the end of the year, what’s actually going to happen with dealer inventory will depend a lot on how dealers feel about 2018, I mean, you could paint a scenario with, again, tax reform and infrastructure spending and lesser regulation and more investment in energy. If all that happens, maybe dealers will be more bullish about 2018 and want to add inventory. So it’s a little bit hard at this juncture to get very definitive about that.
- Southwest Airlines Co. (LUV): There’s three themes that we’re very enthused about. You’ve got the tax reform, you mentioned the regulatory reform and then, thirdly, infrastructure investments which, I will admit, we’re a little bit wary of as to how that might either help or hurt us. But clearly, our primary objective is to modernize the air traffic control system, which falls into infrastructure and could have a huge benefit for aviation and for the traveling public.
- United Parcel Service (UPS): We believe the case for infrastructure development is clear. A world-class infrastructure is the backbone of a modern healthy U.S. economy, and it will certainly reduce costly delays for UPS.
Affordable Care Act (ACA):
- Aetna Inc. (AET): In spite of the best intentions of Washington and industry, the intended goals of the ACA have not been achieved. Millions of Americans remain uninsured and still lack access to affordable healthcare. Companies that have offered public exchange products, including Aetna and other for-profit and nonprofit companies, have collectively lost billions of dollars. These losses have forced most insurers to either scale back their participation or exit completely and in some cases even shut down, as is the case with the vast majority of the Co-Ops. The result is higher costs and more limited access for consumers... I think as we see the evolution on this next step of health reform, there is an opportunity for a retail market that is much more stable than the ACA has been as a way for us to grow... As the public exchanges enter their fourth year, it is clear that in the absence of a significant shift in regulatory policy, the risk pools for the ACA-compliant Individual Commercial products will continue to deteriorate.
- Quest Diagnostics International (DGX): As we’ve said in the past, we never realized the full benefit from ACA that we expected, so we wouldn’t expect any significant nearterm impact if it were to be repealed. We hope that any potential alternative appropriately recognizes the value of diagnostic information services in healthcare. Johnson & Johnson (JNJ): So we’ll have to see when new legislation is announced whether or not these fees and costs associated with the Affordable Care Act remain or if they’re altered in any way. But those have already been incorporated in our business. We’ve adjusted our cost structure accordingly and we have them fully baked into our 2017 guidance as continuing as they currently are.
- FedEx Corporation (FDX): So, we avoided hitting the Cadillac tax because of the steps that we took. Now, if ACA is not modified in that respect, given healthcare inflation, there’s a good chance we would hit the Cadillac tax in the out years, which would result in truly onerous taxes on the benefits above the Cadillac tax level of 40%. So, one of the most important things that we would like to see in the reform of the Affordable Care Act is to do away with the Cadillac tax limit, and that would give us the freedom to do some other things in our healthcare that we might not be able to do as long as we’re on that trajectory towards a 40% excise tax. It really penalizes excellent healthcare plans like we have, relative to other folks.
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IV. Trade policy
Management sentiment on prospective changes to trade policy is mixed, with some in favor of the President’s intention to make American exports more competitive and others fearing that such policies will trigger a trade war. President Trump’s key issue is trade. Last week he tweeted on the topic: “Countries charge U.S. companies taxes or tariffs while the U.S. charges them nothing or little. We should charge them SAME as they charge us!” Hallmark promises of his campaign were the renegotiation of NAFTA, opposition to the Trans-Pacific Partnership, and the imposition of targeted tariffs on China and Mexico.
- Honeywell International Inc. (HON): Yeah, you have to be worried about a trade war. If it gets to that point, it’s not going to be bad just for trade but it’s going to be bad economically. It’s kind of tough to be in economic island now, especially if you’re the number-one economy in the world. So it depends on how all that gets handled. And yeah, of course, it’s a concern for us. On the Defense side, most of our stuff – you’ve heard me say this in the past, but Defense is more of a sales channel for us.
- Chubb Limited (CB): Broadly speaking, we are in a time of uncertainty, economically and geopolitically. On the one hand, the world is a tense place, marked by growing nationalism and populism that are feeding protectionist sentiment. This is a global phenomenon. I might add, while early days, I am concerned about our own country’s potential trade and security posture. On the other hand, in the U.S., the monetary and fiscal changes afoot around tax, regulation of business, infrastructure and higher interest rates, are a real positive for business, jobs and the economy, if implemented in a way that doesn’t exacerbate budget deficits.
- Pfizer Inc. (PFE): Stopping free riding is the way I’d put it. The economy’s free ride on innovation paid for by Americans, clearly it’s trade policy. It’s how we interact and how we do our trade policies and how we negotiate them, and I think the president has been clear that he thinks that they haven’t been negotiated hard enough. And as regards to free riding on American innovation of pharmaceuticals, I totally agree with him. And hopefully we will get something done on that. He certainly has declared his intentions to do so.
- PayPal Holdings Inc. (PYPL): There’s a lot of talk about protectionism, a large percentage of our cross-border trade happens outside the U.S. It’s not impacted by any of this at all. Our average selling price is $60. Think about that. Tariffs only apply to goods and services over $800. So most of this is not going to apply to what we do on a day in and day out basis.
- Morgan Stanley (MS): The bear case would be the retail investor doesn’t engage. There’s a geopolitical or political event which creates enough confusion in the minds of potential issuers that the underwriting calendar doesn’t come back. The M&A pipeline, for whatever reason, is crystallized given some of the changes on the political front including potential tax reform, et cetera, et cetera.