how important is the Trump economic agenda for stocks?

Personally, I’m not a big Donald Trump fan.

In this post, however, I’m taking off my hat as a human being and putting on my hat as a portfolio manager to give my thoughts on how the Trump economic agenda may affect stocks over the coming months.

How I read events so far:

through 1/31/17

–the S&P 500 rose by 10% from the surprise Trump presidential victory through yearend.  Leading sectors were Materials, Industrials and Energy.  The three were all potential beneficiaries of the Trump platform–infrastructure spending, developing domestic energy sources and promoting domestic manufacturing

–the dollar rose by about 7% against the euro.  This came from a combination of hope for accelerating economic growth, and belief that greater fiscal stimulus would allow the Fed to raise short-term interest rates at a faster-than-consensus pace

–promise to reform corporate taxes, to reduce the top tax rate from the present 35% to perhaps 20%, while eliminating loopholes.  Why?  The rate is unusually high in world terms and a key reason for US corporations shifting operations abroad.  My back-of-the-envelope calculation is that tax reform could boost the profits of the S&P 500 by around 10%.  I think it’s reasonable to assume that a large portion of this potential gain was being baked into stock prices prior to the inauguration

 

during 2017

–stock gains, sector rotation.  the S&P 500 has risen by a further 10% since January 1st.  However, the 4Q16 leaders have ceased outperforming.  The big winners have been IT, Healthcare and Consumer Discretionary–all beneficiaries of an expanding, but not red-hot economy, and the first two with substantial non-dollar exposure

–dollar weakness.  the euro went basically sideways/slightly up from early January until April.  Since then, the euro has reversed course, gaining 10% vs the US$.  It’s now about 8% higher than it was the day before the election.  The yen is a more complicated story, because Bank of Japan policy is to weaken the currency against trading partners’.  The dollar has also strengthened against the yen during 4Q16 and has weakened since.  The yen is now about 6% weaker against the dollar than it was in early November.

my take

The poor performance of infrastructure spending beneficiaries since January suggests to me that there’s little expectation on Wall Street today that Mr. Trump will deliver on his promises in this area any time soon.  So not a worry.

The weakness in the dollar has two aspects:

—–it acts as an economic and stock market stimulus.  For a euro-oriented investor, for example, the S&P 500 has barely moved this year.  In other words, to some degree this year’s stock market rise is being triggered by the currency decline

—–it’s also a function of lowered expectations for interest rate rises in the near future.

Both indicate, I think, a tempering of 4Q16 economic expectations for the US.  The fact that the dollar has basically given up its post-election gains argues that this isn’t a worry either.

Substantial tax reform would likely mean a 10% boost to S&P 500 earnings–and therefore arguably a 10% rise in stock prices. A good chunk of this potential positive was factored into stock prices, I think, in late 2016 – early 2017.  The worry that Mr. Trump will not deliver on taxes may have already put a ceiling on stocks around where they are now.  If concrete evidence of Washington dysfunction around the tax topic emerges, that might easily clip 5% off the current S&P 500 level.

Shaping a Portfolio for 2017: emerging markets

Let’s divide emerging markets into two categories:  China and the rest of them.

China

Measuring using Purchasing Power Parity, China is the largest country in the world.  It’s much faster growing than other large economic areas, like the US or the EU.  It’s also accessible to foreigners in several ways:  through Hong Kong-traded stocks, through China-centric mutual funds and ETFs and for individual mainland equities through connections among the Hong Kong, Shanghai and Shenzhen stock exchanges.

I have conflicting thoughts about China today.

The country is currently going through a transition from GDP growth through low value-added, export-oriented industries to expansion through consumer-oriented domestic demand.  This is never smooth sailing.  At the same time, two of its biggest export markets, the EU and Japan, have undergone massive currency devaluations.  This makes the transition more urgent–and potentially much more choppy, since China-sourced products are now much more expensive there.

That’s the near-term bad news.

On the longer-term positive side, the inward, anti-trade turn being signaled by the incoming Trump administration will, I think, mark the shifting of the mantle of world leadership–with its attendant pluses and minuses–from the US to China.  (To be clear:  although I think this may be the signature result of the Trump administration, I don’t think Mr. Trump intends this outcome;  he’s just clueless.  And the real cause is policy failure by the two major domestic political parties over the past decade or more.)

One plus will likely be a greater desire  by foreigners to own Chinese stocks and, because of this, a gradual PE multiple expansion for them.  A potential minus will be more pressure on Beijing to loosen Communist Party control over its financial institutions and its currency, which will subject the renminbi to the speculative ups and downs of currency traders.

My bottom line:  I mostly see bumps in the road for China in 2017.  I’m keeping a small China position, comprised of mutual funds and Macau casino stocks.  But I feel no strong urge to buy more.

Shaping a Portfolio for 2017: Europe

EU and UK

I started out to title this the EU instead of the more generic Europe.  But then I realized we have to treat the UK as a separate issue, even though it exhibits many of the same structural characteristics as the rest of Europe.  So I changed my title.

Two factors about Europe stand out to me as an investor:

currency

–the euro, which cost $1.40 each as recently as 2014 and which went for as much as $1.15 earlier this year, is now trading at $1.04.  A pound sterling, which cost $1.71 in 2014 and $1.45 prior to the Brexit vote, now goes for $1.22.

A 26% decline in the euro vs. the US$ and a 29% fall in sterling are immense moves.  While they represent a catastrophic contraction in national wealth for the individuals and nations affected, they also act as a big boost to the global competitiveness of Europe-based multinational firms.

EU warts showing

–in June, the UK voted to leave the EU. That prompted Scotland to revive its efforts to secede from the UK and become its own (EU member) nation.  Italy, in many ways the Japan of Europe, just rejected reforms that would have put government finances on somewhat better footing and allowed it to address the problems of its woefully weak banks.  Angela Merkel, the political leader of the EU–as well as of Western democracies, many would say–appears to be in deep trouble in Germany because of her stance on immigration.  Greece continues to resist fixing its economy.  France only looks good by comparison.

My stock market experience is that, with the possible exception of Japan, politics rarely matters.  Better to focus on company by company prospects than media headlines.  However, this is a real mess.

my take

My overall economic view is that Europe is about two years behind the US in recovery from recession.  That would suggest domestic enterprises are in for another year of struggle before we see strong signs of general economic growth.  Currency weakness should strongly accelerate the pace of improvement.  The ongoing efforts of traditional political/economic elites to preserve their place of privilege without regard to the cost to their countries should retard meaningful progress.

To my mind, Europe remains a special situations market.  I think the best course for equity investors is to be underweight and play the currency rather than the economies.  That is, to remain with multinational stocks based in Europe which have significant non-European sources of revenue.  Hotel companies with US presence, and which also stand to be beneficiaries of increased tourism in a now-cheap Europe, seem to me to be particularly well-placed.

 

 

 

 

 

Shaping a Portfolio for 2017: a look back at 2016

The first step in formulating an investment strategy for the coming year is to check back to see how well you did in forecasting what would be happening in the current year.

Here goes.

I thought that the best economy in the investable would be the US, that the EU would begin to rebound from a poor 2015 and that the emerging/frontier markets should be avoided.  Ok so far.

I thought that eps growth in the US would be +6% – +7%, that interest rates would remain ultra-low, that PE multiples would neither expand nor contract, and that individual stock selection, rather than industry or sector selection, would be the key to success.   Mostly ok.

 

Actually, if the year had ended on November 1st, my year-ago thoughts would have turned out to be pretty accurate.  Yes, I didn’t foresee that Britain would vote to leave the EU, but of course that referendum didn’t need to be called in 2016 and the June date for voting was only set in February 2016.  And I didn’t anticipate the January-February market swoon that started the year off.  That doesn’t bother me so much, either.

So until the approach of Election Day, I was doing about as well as anyone would have a right to expect.  The S&P was up 4% for the year on Halloween–vs. my +6% – +7% for the full year.  Interest rates remained ultra-low.  It appeared a colorless candidate favoring maintaining the status quo would (barely) beat a tacky reality show star, a political neophyte radiating bigotry and trailing a cloud of dubious business dealings, in the race for president.

Then Donald Trump won the election.

Since then, +4% on the S&P has become +11%.  The US$ has risen sharply.  Stock picking has become less important than sector selection–favoring energy, industrials, materials, that is, the areas that benefit the most from accelerating economic growth.  Tech and dividend stocks have been on the outside looking in.  The promise of large-scale infrastructure spending suggests the Fed will be free to raise interest rates next year at a faster pace than I imagined possible.  Rates have, of course, already been going up in anticipation of Fed action.

As a result, the A I would have awarded myself two months ago is probably now a B.

 

 

 

 

 

a post-election scoreboard: day one of outlining a strategy for 2017

Financial markets around the world have been remarkably active since the improbable election of Donald Trump as the next president of the United States.

  1.  The S&P 500 has risen by 5.8%
  2. The dollar has risen by 5.6% against the euro
  3. The dollar has risen an amazing 13.5% against the yen
  4.  The Eurostoxx 50 has gained 7.0%, meaning US$ investors have a loss of about 1.5% from holding large-cap Euroland shares
  5. The Nikkei 225 is up by 11.4%, meaning US$ investors have a loss of about 2% from investing in Japanese stocks.

These are all big moves.

To my mind, in the US the correct way to interpret them is this:   Wall Street believes paralysis in Washington is at an end and that resulting fiscal stimulus will allow the Fed to raise interest rates from their current extraordinary lows.  Put it another way, the focus of treatment for the economy will be away from life support and toward a return to health.  The enhanced potential for future earnings growth is generating both upward stock movement and higher interest rates.  The latter is causing the dollar to rise.

For the rest of the world, I think, a different, more derivative, dynamic is at work.  If investors are looking to the US as the locomotive that will pull Japan and the EU out of their current malaise, I think that’s a secondary effect.  I think the rise in those markets is being driven by the spur to their export-oriented industries given to them by the  precipitous falls in their currencies.

(An aside:  there’s a certain irony in having the professed (but looney-tunes, in my view) Trump agenda of bringing low-wage low-skill jobs back from developing economies having been so immediately, and deeply, undermined by post-election currency movements.)

What to make of all this?

I interpret what’s happening as the start of a very traditional stock market pattern.   When an economic upturn is beginning,  commodities-related industries react in an anticipatory way to expected future events and then move more or less sideways until there’s clear evidence in earnings that the anticipation is correct.  Earnings gains create a second, earnings-based upward movement.

Put a slightly different way, the market moves from having a bad future priced in to a neutral position.  It then reacts to good things as and when they begin to occur.

A third formulation: the post-election move is akin to the beginning of a business-cycle driven bull market.  That’s a little strong, since I don’t think the typical 30% gains of a bull market are in store for us over the next couple of years.

But I do believe we should be thinking aggressively, not defensively.

What would change my mind, or at least cause me to rethink?  …weakness in the US$, or some sign that the new administration has no intention of carrying out its agenda of breaking with business as usual in Washington.

More tomorrow.