As we approach Donald Trump’s first anniversary as president of the United States of America many will be looking at what he has achieved during his first year in power. From the birth of ‘fake news’ to volatile international relations, it goes without saying that the last 12 months have been eventful to say the least.
But what impact have his policies and proposals had on the high yield bond market and who can we count as the winners and losers from his time in power so far?
Substantial changes to the tax code will have a significant effect on high yield issuers.
Lower headline tax rates will benefit some businesses as they pay less tax, but this will come at the cost of interest only being deductible on up to 30% of Ebitda until 2022 and on 30% of Ebit after that. For highly indebted issuers, the interplay of these effects will be negative.
At present such businesses essentially pay no tax given the high levels of interest recorded on their balance sheets. However, once Trump’s changes come into play, their interest shield will be negated and those with little to no net income will not benefit from the promise of lower income tax rates either.
Given their weaker credit quality and low cash flow levels such speculative grade businesses are amongst those most exposed to such headwinds.
Longer term, these changes should lead to a greater incentive to have less leverage which will be positive for the high yield market as the risk of default should decline.
Given America’s importance to the global economy as a whole such change will likely have a wider knock on effect on the international high yield market.
Undoing the Clean Power Plan
Under the Obama administration the establishment of the Clean Power Plan made it inefficient for businesses to run coal based power plants.
However, with Trump’s proposals to reverse the programme, both renewable and non-renewable energy sources will experience a significant impact on demand.
Evidently, the respective industries will be affected in contrasting directions with non-renewable focused portfolios likely to benefit from the legislative reversal, whilst renewable sources may see a drop off in appetite.
The Trump administration has also proposed paying higher prices to coal and nuclear power plants as a reward for being a more reliable source of electricity in further support of the non-renewable energy sector.
Although a repeal of Obamacare has not come to fruition, other changes to legislation are likely to have a significant impact across the wider healthcare industry.
As part of the tax reform bill, the penalty for not obtaining health insurance was set to zero. On the administrative front, certain payments to insurers were eliminated leading to higher premiums on Obamacare exchanges, as well as other actions which will likely to lead to fewer individuals choosing health insurance.
As such, in addition to the insurers themselves, related markets may experience substantial volatility.
Hospital operators for instance would struggle to treat people without insurance, whilst dentists, managed care providers and other medical practitioners would also suffer the negative fallout from the changes.
On the other hand, Trump’s proposal to soften regulation within the pharmaceuticals industry would likely lower the cost of bringing new drugs to market, thus driving positive momentum across this subsector of the healthcare market. Having said this, generics may as such be able to come to market faster which could be negative for some pharmaceutical companies.
Whilst it remains unclear whether Trump will be able to deliver a full repeal of Obamacare in the long term, through more modest changes to various laws the Trump administration continues to have a significant effect on one of the largest sectors of the US economy.
Though Trump generally speaks out in favour of relaxed regulation in order to accelerate growth after years of sluggish performance, he does support stricter guidelines in other areas.
Aside from the healthcare and energy industries, Trump supports the renegotiation of Nafta which aims to ensure companies cannot import parts or products from Mexico and Canada without paying higher tariffs.
Given that entire supply chains have been built around the existence of the Nafta agreement, significant changes to it may prove hugely detrimental to the productivity and profitability of certain companies. Substantial disruption may in fact threaten the existence of some businesses altogether.
Though some industries, such as the automotive, steel, and retail sectors, would feel such developments more strongly than others, ultimately such change as a whole would lead to increased volatility which would have an inevitable impact on the supply-demand balance of the high yield market.
Winners vs. losers
Although one of the key lines throughout Trump’s presidential campaign was to put the US economy and business first, there seems to be a clear differentiation between those who stand to profit from his administration and those who do not.
Whilst a number of the president’s controversial proposals may be unfavourable to certain industries, there is no denying the benefit to others.
Having said this, the full impact will often depend how much of the above can be enshrined into law versus more simple regulatory changes.
Either way, it is clear that the next three years will be an interesting period for the high yield market as we continue to experience the impact of the ‘Trump effect’ in full force.
Who will come out on top? Only time will tell.
Kyle Kloc is a senior portfolio manager at Fisch Asset Management