John Stephenson, a regular columnist in The MoneyLetter, says there is little doubt that the outlook for the stock market’s path higher will most likely be a bumpy one, as a political neophyte learns to navigate the swamp that is Washington. In the meantime, financial stocks and technology stocks will likely be the big beneficiaries of Trump’s proposed policies of lighter regulation and lower taxes and should be bought on weakness.
The ‘Trump Bump’ is at a crossroads for the new U.S. president in his first 100 days, with analysts and investors calling for details on the proposals that have helped drive one of the biggest post-election stock market gains in history. As the rally begins to lose steam, bouts of profit taking have emerged as the market awaits word on the new administration’s actual policies.
Investors bought stocks and sold bonds in the immediate aftermath of Mr. Trump’s surprise victory on the hopes that tax cuts, infrastructure spending and lighter regulation would translate into faster economic growth and healthier corporate earnings. But now we are at the point where the animal spirits unleashed by the Trump election victory meet the sausage making that is Washington DC.
Deciphering the policies of the new administration will be no easy task, as shown by the strong fluctuations in the U.S. dollar recently. In mid-January, Mr. Trump said that the dollar, which was trading at 14-year highs against a basket of major currencies, “is killing us,” making it impossible for U.S. companies to compete with Chinese manufacturers. His comments triggered a sharp sell-off in the dollar. This was followed a few days later by comments by Steve Mnuchin, the treasury secretary, reiterating the longstanding “strong dollar” policy of past governments at his Senate confirmation hearing.
History shows that barely half of what presidents campaign on typically gets passed. With some 242 promises made during the campaign, many will not live to see the light of day. This is likely to manifest itself in increased volatility and a high likelihood of overpromising turning into underdelivering. The political challenges in enacting fiscal stimulus, still-subdued global economic growth and the dangers of trade wars will buttress the stock and bond markets this year.
Bank of America Merrill Lynch’s economists said in a recent note that a “serious escalation of U.S.-China tensions are the biggest danger confronting the global economy in the coming year”. At a minimum, they expect China to be declared a “currency manipulator” and for specific cases to be brought against China. Some of this uncertainty is reflected in forecasts for the 10-year U.S. Treasury yield, one of the most widely watched interest rates in the world. The average forecast, according to Bloomberg, is for the yield to rise slowly from 2.5 per cent to 2.8 per cent by the end of the year. But the individual forecasts vary widely, ranging from 1.35 per cent to 3.5 per cent.
Investors are cautious
Investors have begun to position themselves more defensively by increasing cash or hedging against a potential resurgence in volatility. Other investors have become even more cautious, with many betting against equities in the week ahead of Mr. Trump’s inauguration. Short interest, or bearish bets, on the SPDR S&P 500 exchange-traded fund, the largest ETF tracking the benchmark, rose to $32.9 billion on January 19th from $30.8 billion a week earlier, a reversal of the trend for the two months after the election.
Financial stocks, which led the market in the aftermath of the Trump victory, have been under pressure in recent sessions. The KBW NASDAQ Bank Index slid 2.8 per cent in the five days ending January 20. Investors pulled $749 million from the global financial sector for the week though Wednesday, the first outflows in 17 weeks.
History suggests caution when a new president takes office. In the month after a president is sworn in, the median change in the S&P 500 has been a decline of 0.7 per cent according to Bespoke Investment Group, with data going back to 1928. When a Republican president replaced an outgoing Democrat, the decline was more pronounced, with a median drop of 2.6 per cent.
What I Recommend
The fuel for the market’s rally so far has been the potential for new policy out of the Trump administration. In the immediate aftermath of the election it was the prospect of fiscal stimulus, lighter regulation and reduced taxes. If the new administration can continue to demonstrate tangible progress on deregulation, tax reduction and its growth agenda, then the market rally is likely to continue for some time. As well, the tweets from the new American president asserting an alternative reality will need to remain muted for the rally to be supported.
President Trump recently reiterated his false claim that at least three million illegal immigrants cast ballots for Hillary Clinton. He called for an investigation into voter fraud, even though his own legal team has argued that no such fraud has occurred. For the market rally to be sustained, the president will need to curb his impulses to tweet as they ultimately undercut his legitimacy and cast the presidency in a poor light.
Technology stocks should out-perform
Despite concern over the impact of a border tax and a very slow ramp-up in the first few weeks after the election, technology stocks should continue to be a top-performing sector. No sector is larger, offers better growth and excellent valuation than the technology sector.
One company that I really like is Facebook, Inc. (NASDAQ—FB), the world’s most popular social networking site, with over 1.7 billion users. Despite its huge number of users, Facebook is still growing its user base at an annual rate of around 15 per cent. In addition the personal information and data that users upload to the site is without peer and form an extremely valuable resource for the company. The company has many additional levers of growth, which include the possible extension of video advertising. Facebook’s margins are extremely high, with EBITDA margins in the low-60-per-cent range. I have a ‘buy’ rating and a twelve-month price target of USD $170 per share for technology stock Facebook.
Amazon.com Inc. (NASDAQ—AMZN) is a terrific company. It is the largest retailer on the Internet and operates in seven countries with over 300 million customers worldwide. Currently only 11 per cent of U.S. retail sales occur online; as the largest Internet retailer, Amazon should be a beneficiary of the move to more and more online sales. Amazon.com accounts for 20 per cent of total online retail sales in the United States. The company offers very strong, mobile positioning and many infrastructure advantages that allow Amazon to facilitate next-day and same-day delivery, which should allow the company to take market share. I have a ‘buy’ rating on this consumer goods stock and a twelve-month price target of $950 per share for Amazon.com.
Another name that I really like is Alphabet Inc. (NASDAQ—GOOGL), a top search destination on the web and a leading search marketing platform for advertisers and merchants. Google has long been the major leader in search advertising, accounting for more than 70 per cent of global search ad revenue. Its market share has continued to grow, and its very strong position in mobile and ongoing innovation is likely to sustain its leadership for the foreseeable future. The huge scale advantages that Alphabet enjoys and its very substantial investment in capital expenditures ($35 billion USD over the past five years), as well as in research and development ($32 billion over the past five years), gives this technology stock unusually deep competitive moats around its business. I have a ‘buy’ rating and a twelve-month price target of $1,100 per share on Alphabet Inc.
Whither the loonie?
Given the faster economic growth rate in the U.S. and an increasing interest rate differential between the two countries, the U.S. dollar is likely to increase in value versus the Canadian dollar. I think that there is a strong likelihood that the Canadian dollar will fall toward the 70-cent dollar range by year-end, helping to act as an important tailwind for Canadians investing in U.S. companies.
While I believe caution should be the order of the day given the long march higher for the market, I do believe that the path for the market in 2017 is likely higher. There is little doubt that this path higher will most likely be a bumpy path, as a political neophyte learns to navigate the swamp that is Washington. Financial stocks and technology stocks will likely be big beneficiaries of Trump’s proposed policies of lighter regulation and lower taxes and should be bought on weakness.
John Stephenson is an award-winning portfolio manager and the President and CEO of Stephenson & Company Capital Management Inc. in Toronto. He is the author of “The Little Book of Commodity Investing” and “Shell Shocked: How Canadians Can Invest After the Collapse.” He is also the publisher of Strategic Investor (www.StephensonFiles.com). He can be reached at (647) 775-8360 or (844) 208-8817, or firstname.lastname@example.org.
This is an edited version of an article that was originally published for subscribers in the February 2017/First Report of The MoneyLetter. You can profit from the award-winning advice subscribers receive regularly in The MoneyLetter.
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