Why Wall Street is Excited about Trump’s first step toward Deregulation

happy-traderLast week, on March 7, a curious item appeared in the Federal Register. The Department of Commerce issued a request for information from manufacturers: “The Department of Commerce is seeking information on the impact of Federal permitting requirements on the construction and expansion of domestic manufacturing facilities and on regulations that adversely impact domestic manufacturers.”

The request asked manufacturers to list the top four regulations they believe are most burdensome for their business, and asked for comments by March 31.

It’s the opening salvo in a major battle to reduce regulations, one of the three main “pillars” of the Trump agenda, along with tax reduction and infrastructure spending.

Much has been made about the potential impact of a tax cut on S&P 500 earnings, but traders are no less enthusiasticred tape about the potential impact of a reduction in regulations.

While several studies have indicated that a reduction in taxes could boost earnings 8% or more, (see my Trader Talk from yesterday), a reduction in regulations can also have a significant boost on earnings.

The issue, of course, is that very few regulations have been changed, so it’s not yet possible to run models about how fewer regulations will impact earnings.

But just taking President Trump’s promises at face value would imply a boost to the bottom line. He signed an executive order in January to scale back regulations on businesses, promising to cut regulation by 75% by eliminating two regulations for every new regulation enacted.

Just think through what would happen to earnings and margins if even a small part of that promise came through.

For big industrials like Caterpillar, fewer regulations will help drive down the cost of production. That will improve the bottom line.

For other industries that employ large numbers of people, even a modest change in regulations could make a big difference. The trucking industry, for example, has long complained about Federal Motor Carrier Safety Administration rule that limits drivers’ drive time per day and over a seven-day period. The American Trucking Association has been lobbying to ease those rules.

For financials, fewer regulations will enable them to reverse the massive increase in corporate compliance staff and may lead to an increase in trading activity.

This could lead to a very significant improvement in the bottom line for banks. A recent Vanity Fair article noted that the six largest U.S. banks by assets spent $70.2 billion in 2013 on regulatory compliance, nearly double what they collectively spent in 2007. At JP Morgan, 43,000 of its 236,000 employees — 18.2% of its workforce — are now involved in compliance, twice the number in 2011. Author William D. Cohan concluded: “[T}he job of nearly one out of every five people working on Wall Street these days is to watch what four other people do all day long.”

Again, the lack of details make modeling difficult, but you get the drift: it would be a positive for earnings and its close cousin, margins.

Margin, simply put, is the ratio between a company’s revenues and expenses. It can be sliced many ways (gross margin, operating margin, net profit margin) but is roughly a measure of profitability.

It’s probably the single most important metric for those looking at profitability trends.

According to Thomson Reuters, the S&P 500 hit historic highs on margins of just over 10% in 2015, and it’s been drifting around that range since then, currently at 10.1% for the first quarter of 2017.

There are several reasons margins have struggled to improve, but everyone agrees that one of the primary problems is that sales growth has been stagnant while the cost of doing business — the cost of goods sold (COGS), which is the cost of materials and the direct labor costs used to produce the goods — have been rising. More time, more bodies spent in compliance is a key factor in driving up those costs.

That’s where the Commerce Department request comes in — it’s a follow-up to the president’s executive order and is just the start of an attempt to quantify some of the accumulative damage from excessive regulations.

One director of a local government economic development organization involved in building industrial development parks wrote in to describe the quagmire around getting wetland approval for his projects: “Dependent [sic] upon the type and ‘value’ of the wetland being impacted, the costs can be thousands of dollars per acre.”

One small business owner bitterly complained about electrical licenses he has to have he never used to need, and crane certifications he is required to have that don’t apply to his business: “I have a small 10-employee business, and between insurance and other requirements, we can not stay afloat.”

You’ll hear a lot more of these types of comments from Wilbur Ross’ 1-FmAP3hdDWrXQXkJaqwrVpACommerce Department in the coming months.

But you can already see why Wall Street is enthusiastic that a reduction in regulations is a second crucial aspect of the Trump agenda.

Source: CNBC

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