Trump and the Republican party are having a difficult time passing legislation despite holding a majority of seats in both the House and the Senate. After a number of failures to get healthcare measures passed, tax reform is now moving to the forefront.

Our core position is that Trump is trying to engineer a boom. It will not be sustainable and will likely be followed by a bust that leaves the US economy in a worse position but that is a future problem – positioning the portfolio for the boom is the current issue.

The proposed tax cuts are badly targeted by giving most of the benefit to the rich and to companies, trickle down is unlikely to work, the tax cuts are unsustainable, and they are only a short-term “sugar hit” for the US economy, I understand all the negatives. But if it is anywhere near Trump’s promise then it’s going to be such a huge stimulus that you don’t want to stand in the way of it as an investor.

There are three parts, we don’t know which will be in the final package, but we expect at least some of the measures to pass:

• Company Tax cuts, currently proposed to be cutting the company tax rate from 35% to 20%. While this is a big change, many US companies already pay less than 35% in practice, and so we expect the effect on earnings will likely be around 5-10%% in year one and probably 1-2% stronger for a few years as companies restructure tax structures
• Personal tax cuts. Lots of simplification, the net outcome being largish tax cuts for higher income individuals, smallish tax cuts for low income. Badly targeted, but still a stimulus for the economy.
• This involves incentivising US companies to bring back cash currently held internationally. In simple terms, US companies can defer tax on international profits by holding the money offshore. Trump is proposing tax incentives to bring this money back. This is a one-off increase in tax revenue, and likely a one-off increase in buybacks and dividends. Both of these are USD bullish. This is a short-termism at its best – sacrifice the future to juice current economic activity.

The playbook (subject to being able to find stocks at the right price) is:

Round 1: Buy US stocks for the sugar hit, plus exporters in non-trade pact countries

The US will go deeper into debt – a good thing for global demand.

This means the end of the rate cycle (although the upswing may not last that long). The US dollar is likely to be strong, and I suspect that the US dollar will offset a lot of the benefit for the US – i.e. US demand increases, but a decent amount of that benefits the rest of the world through increased exports to the US.

In aggregate, this is a buy US equities story, probably go light on US exporters or companies that are import exposed as the US dollar strength is going to hurt them the most. In other markets, try to avoid exporters who will be hit by trade sanctions (Mexico, Canada, China) and look for those that might fly under the radar and benefit from US demand (UK, Europe, maybe even Japan). Increased demand puts a floor under a lot of commodity prices; some will rise.

Keep in mind that some of this is already priced in.

Round 2: Reduced world trade, increased protectionism

Say hello to higher costs in the US. Net/net the average Trump voter will probably give back from a higher currency and increased inflation any gains from (increasingly unlikely) protectionism.

Will a US/China trade war break out or will it just be lots of noise and posturing while in the background the increased US demand benefits the Chinese economy? Hard to tell, but we are leaning towards noise and posturing rather than tangible measures – especially as Trump needs China to help with North Korea. Also, Republicans are generally protrade, and anti-trade measures are less likely to get support.

US companies will struggle with profit growth due to higher costs (with the higher USD), fading stimulus.

Round 3: Unsustainability become apparent

If you don’t believe in trickle down (I don’t) then at some stage the debt becomes unsustainable, and taxes need to be lifted. Hopefully, it’s not too close to the time that the Chinese debt becomes unsustainable… Anyway, that is a future problem – probably 2-3 years away at least, maybe 5 years away, at which time the US is in a worse position than today, the core problem of too much inequality/lack of demand still exists (probably gets worse).

Maybe it is the Euro falling apart, maybe it is another external shock, but the core thesis of a lack of demand largely driven by inequality remains, and in 3-5 years we are back where we started – but with a much higher US debt balance.

So, we should play the boom but keep a sharp eye on the bust.