3 U.S. blue chip financial stocks to buy

Regular MoneyLetter columnist John Stephenson offers his stock market outlook for the early days of a Trump administration. Financial stocks should be among the first big winners because of the possibility of the repeal or the watering-down of the Dodd-Frank Act. As well, higher interest rates positively impact banks’ net interest margin, a key metric of bank profitability. He picks his three favourite blue chip U.S. financial stocks to buy now.

The early days of President-elect Donald Trump have been a boon for U.S. stocks—to the exclusion of most other markets. The winning streak continued unabated for two weeks after the election with the S&P 500 index, Dow Jones Industrial Average and the NASDAQ Composite Index all rising to record closing highs. The Russell 2000 index of U.S. small caps, which tend to do well when the domestic economy is strong, also hit a record recently—the first time all four indexes hit closing records since December 31, 1999.

Outside of the U.S. and Canada, 42 out of 46 foreign markets in the S&P Global Broad Market Index have declined since the election. Bonds staged a sharp sell-off in the week after the election, erasing an estimated $1 trillion of value globally as investors braced for more inflationary pressure and higher interest rates under a Trump administration.

Trump’s shock victory left markets gyrating dramatically in the immediate aftermath, since most investors were not prepared—or hedged—for a Trump victory. As a consequence, bond prices tumbled and equities soared, particularly in sectors that are likely to benefit from Trump policies, such as pharmaceuticals and infrastructure.

Consensus wisdom suggested that Donald Trump’s stunning election victory would put markets on the defensive and send investors scrambling for safety. Before election night, there was little doubt that the market was pulling for Democrat Hillary Clinton. A tightening of the polls in the final weeks of the campaign saw the S&P 500 index’s longest losing streak in more than 35 years. Nine consecutive days of losses ended only when the FBI announced two days before the vote that Ms. Clinton should not face criminal charges over the handling of classified information related to her private email server.

Market outlook enthused by Republican pro-business bias

When it became apparent that Mr. Trump was going to win the White House, an initial flight to safety began to overwhelm markets. Gold, U.S. Treasuries, the Swiss franc, the euro and the Japanese yen surged and risky investments were dumped. As markets opened the day after the election in North America, however, investors regained their composure and the safety trade seemed to reverse swiftly. Gold’s early gains of more than $63 per ounce, or nearly five per cent, were wiped out. And the Dow pulled off a swing of more than 1,100 points from its pre-market low to its close on the day after the election.

The enthusiasm that developed in U.S. markets was a function of a clear victory for Mr. Trump rather than a contested result, and a general belief that the Republicans are a pro-business party. Investors appeared to be pricing-in the expectation that Congress will keep the most positive aspects of Trump’s proposals, such as tax cuts, and blunt the most harmful aspects (protectionism).

Industrial companies and financial stocks—banks especially—have led the surge over the last few weeks, as investors poured money into stocks they believe could benefit from possible increased government spending, decreased regulation and a pickup in inflation under a Trump administration.

Biotechnology stocks jumped as analysts and investors concluded that drug pricing restrictions would have been more likely under Mrs. Clinton. At the same time, money rotated out of some of the biggest market winners since the financial crisis, including some technology stocks such as Amazon.com, Alphabet and Facebook, which are all down in the aftermath of the election, despite the broader U.S. market’s steep rise.

Investors pulled $400 million from emerging markets equity funds and $73 million from emerging markets debt funds in the week after the U.S. election, according to Bank of America Merrill Lynch, the largest withdrawals in 19 weeks in both cases.

Market outlook for a Trump administration

But as the shock wears off, investors are faced with the prospect of what President-elect Trump will actually do. Will he be a moderate, pragmatic businessman or will he gut trade pacts and shift American leadership into reverse?  During the campaign Mr. Trump made trade a punching bag for an angry electorate, but his pitch to a frustrated base was oversimplification at best, crafted for stump speeches and soundbites.

He argued vehemently against trade alliances, suggesting that: “We don’t make things anymore.” This despite the fact that the United States is still one of the most successful countries at making things and selling them to the rest of the world. In September, U.S. real goods exports hit $123.6 billion—a record. Industrial production is also rising, up 29 percent since 2009, when the U.S. economy was emerging from a global recession.

In a globalized world, with U.S. blue chip stocks reliant on a sizable amount of foreign revenues, trade barriers and a much stronger dollar are not ideal. The poor performance of U.S. technology stocks since the election stands out as a red flag.

Inflation—Up, up and away?

A Trump presidency is inflationary. It took just a few hours after his win for investors to appreciate the prospect of a pro-growth, business- and regulation-friendly administration that wants to prime the economy via tax cuts and massive infrastructure spending. If globalization and free trade were major forces of disinflation, then any increase in protectionism must be inflationary. Similarly, a pledge to deport 11.3 million undocumented immigrants (7 per cent of the U.S. labour force) may be a logistical nightmare, but any steps taken that restrict the opportunity for these immigrants to find work in the U.S. would result in possible labour shortages—in itself inflationary.

Inflation is bad news for those investing in bonds. Recently, the yield on 30-year U.S. Treasuries rose above three per cent for the first time since January, while 10-year yields rose to 2.3 per cent. Only four months ago, the 10-year yields were a mere 1.3 per cent. Mr. Trump’s big spending plans have spooked bond investors, who evidently think the era of low interest rates and benign inflation might be coming to an end. Bonds, particularly long-dated bonds, and high-yielding equities will struggle as the yield curve continues to steepen. Electric utilities, telecoms and REITs will likely underperform the broad market as Mr. Trump unleashes his economic plan.

3 U.S. blue chip financial stocks I recommend

The likelihood of President Trump enacting his entire myriad of confusing and contradictory policies seems highly unlikely. The market has spoken and the direction for U.S. financial stocks, industrials, healthcare stocks and materials companies should be higher in the months ahead.

Financial stocks should benefit under a Trump presidency because of the possibility of the repeal or the watering-down of the Dodd-Frank Wall Street Reform and Consumer Protection Act that has hobbled banks. As well, higher interest rates positively impact banks’ net interest margin, a key metric of bank profitability.

1. One company that I like is PNC Financial Services Group (NYSE—PNC), one of the largest diversified full financial services providers in the United States. The company is engaged in regional community banking, corporate banking, real estate finance, asset-based lending, wealth management, asset management, and global fund services. Most of PNC’s business is focused on traditional banking, with a commercial/consumer loan split of 65-35 per cent. An improving economy should benefit PNC, leading to solid loan growth. I have a ‘buy’ rating and a twelve-month price target of USD $135 per share for PNC Financial Services Group.

2. Citigroup Inc. (NYSE—C) is one of the biggest banks in the U.S. and the company is well into a multi-year turnaround. Citi has approximately 200 million customer accounts and does business in more than 160 countries and jurisdictions. With more than 50 per cent of its revenues coming from outside of North America, this global financial stock is the best-positioned U.S. bank to benefit from emerging market growth.

The experienced turnaround management team, led by Chairman Michael O’Neill and CEO Michael Corbat, is in the midst of “shrinking the company to profitability”. Management is maximizing the profitability of the company by continuing to strengthen the balance sheet and build upon its Global Consumer Bank and Institutional Clients Group. At current prices, Citigroup stock appears undervalued relative to its $74.51 stated book value per share and $64.71 tangible book value per share.  I have a ‘buy’ rating and a twelve-month price target of $75 per share for Citigroup Inc.

3. Another name that I really like is Morgan Stanley (NYSE—MS), a leading investment bank. Morgan Stanley’s strategy is to improve its return on equity by containing costs.  More than half of the firm’s revenues come from the Wealth Management and Investment Management arms of the business, divisions which should do well with an accelerating economic backdrop. I have a ‘buy’ rating and a twelve-month price target of $50 per share on financial stock Morgan Stanley.

Short and long-term market outlook for Trumponomics

While ultimately Donald Trump’s economic blueprint for the economy may eventually lead to a recession in the U.S. as the economy overheats, in the short-term a bout of inflation is a welcome break from the slow-growth environment we’ve been dealing with for the past eight years. A dramatic increase in spending, a slashing of useless regulation and a reduction in corporate and personal taxes under a Trump administration are good for stocks. The market is likely to continue rewarding these policies. Cyclical stocks that are most positively impacted by the benefits of an accelerating economy should be emphasized over more counter-cyclical or defensive stocks. In this type of stock market a value approach will likely outperform a growth style of investing, and investors should underweight dividend or yield strategies that will underperform the market in a rising-interest-rate environment.

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 jstephenson@stephenson-co.com.


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