Assessing Reactions to Trump’s Victory
publication date: Nov 10, 2016
author/source: Kris Rosemann and Brian Nelson, CFA
Image Source: Gage Skidmore
Donald Trump will be the 45th President of the United States of America. Let’s dig into some of the reactions across the market. We’re keeping our cool.
By Kris Rosemann and Brian Nelson, CFA
The global markets often don’t know what to make of surprises, a characteristic that was on full display as news came rolling in that Donald Trump would soon become the 45th President of the United States, “trumping” Secretary Hillary Clinton in a decisive electoral college victory, despite the popular vote eventually going to the Democratic candidate. In the wee hours of the morning Wednesday, November 9, major markets across the globe were in shock, showing red almost across the board. At one point early Wednesday, futures on the Dow Jones Industrial Average (DIA) had plummeted as much as 800 points.
But what a change in sentiment brought about by Trump’s victory speech to “bind up the wounds of division,” perhaps borrowing a phrase from Abraham Lincoln’s second inaugural address, where the 16th President had sought to “bind up the nation’s wounds” after years of conflict that pitted brother against brother in one of the worst catastrophes of the 19th century. Embracing Trump’s assuring words, major market indices in the US (SPY) rallied back hard and have since reversed heavy losses and then some, suggesting the initial reaction by market participants was not driven by careful consideration of Trump’s policies but rather by a knee-jerk reaction to an election result that few had thought was possible (including almost all the pollsters). Since the initial scramble to assess the aftermath of the surprise Republican victory, stocks have continued to rally Thursday, November 10, as a Trump Presidency is being viewed as business-friendly, despite protests by disenchanted Democrats across major cities in the US.
Even as markets continue to price in better-than-even odds of a rate hike before the year’s end, many market observers continue to question just how aggressive contractionary monetary policy will be in light of the Trump camp expressing differing views at differing times, sometimes claiming support for low rates, and at other times, accusing the Fed of aligning itself too closely with the Democratic party. Regardless, the 10-year Treasury yield (IEF) has jumped considerably in light of the election news, now sitting north of 2%, a move that has sent the bond markets (BND) and most REITs (VNQ) tumbling, “Podcast: REITs, Interest Rates and Beyond!” We continue to be mindful of the inverse relationship of interest rates and REIT equity prices, the latter having many bond-like qualities. We also note that a rising 10-year Treasury yield, often the benchmark rate used across most stock valuation models, will have a negative impact on equity values, provided future growth rates in such models are not changed for the better.
Internationally, the President-elect has also stated plans to renegotiate or withdraw from NAFTA and the Trans-Pacific Partnership, potentially impacting global trade and economic activity. Kansas City Southern (KSU), which owns the most direct rail route between Mexico City and Laredo, where more than half of all rail/truck traffic between the US and Mexico cross the border, is facing the greatest potential negative outcome, while others such as cement-maker Cemex (CX) may have a mixed fate as fewer multi-national entities expand into Mexico, offset in part by increased construction demand to build a controversial wall between Mexico and the US, a priority in President-elect Trump’s first 100 days in office. Relative to the US dollar, the Mexican Peso (MXN) has fallen to all-time lows following the election results as capital leaps out of the country (EWW) in light of comments made on the campaign trail by the President-elect. A cheaper Mexican peso, however, may be a boon for passenger air travel demand, specifically into vacation destinations in Mexico (namely Cancún), which could be a surprise source of upside for Grupo Aeroportuario del Sureste (ASR), even as currency impacts weigh on shares. The firm’s airport in Cancún accounts for ~80% of its revenue and is the second most frequented in Mexico after only Mexico City.
The Asian markets, those impacted by Trump’s comments on the Trans-Pacific Partnership and his suggestions of a ‘trade war’ with China (FXI), saw some of the most drastic sell-offs immediately following the news that Trump would win the election. On the campaign trail, he accused China of currency manipulation, and Trump’s economic adviser Peter Navarro has been a proponent of taking a stronger stance against the country. However, Chinese markets have turned from their declines and have also participated in a meaningful rally, which can be attributed in part to the President-elect's victory speech, where he promised to deal fairly with all people and all nations, while continuing to put America's needs first and foremost. It appears as though his speech has assuaged the idea that President-elect Trump would destroy global trade agreements, more specifically, with China.
Still, industries feeling the negative impact of Trump’s Presidential victory are many. Concerns over reimbursement rates in the event that a Republican Congress, soon to be headed by a Republican President, will dismantle the Affordable Care Act (Obamacare), or certain parts of it, have hospital shares (IHI), namely those of HCA Holdings (HCA), Community Health Systems (CYH), and Tenet Healthcare Corp (THC), shuddering. The auto industry and General Motors (GM) and Ford (F) specifically had been investing a significant amount of capital on globalized production and fuel-efficiency initiatives, but Trump’s plans to return auto manufacturing jobs to the US may bring the feasibility of incremental non-US manufacturing capital investments into question. Other business-friendly plans could help offset such negativity, however, and while we generally believe Trump’s victory is an overall positive for Rust Belt States, we’ll be monitoring the impact on the auto industry closely.
The President-elect’s opinions of climate change and proposal to eliminate a subsidy on electronic vehicles could also impact those targeting energy optimization in the auto sector. Tesla’s (TSLA) shares continue to face pressure, for one, and we continue to believe that the electric-car maker’s equity is a speculative lotto ticket that is not likely to pay off. Solar and alternative energy stocks (TAN) have also been hit due to the anticipation that the President-to-be will allocate more resources to traditional energy sources such as oil, gas (NGAS), and coal (KOL). This is more bad news for a solar sector that continues to face a glut of overcapacity, at least from the perspective of bellwether First Solar (FSLR), which struggled tremendous during the third quarter of 2016 amid an industry surplus of panels.
Tech stocks (XLK), including giants Apple (AAPL) and Microsoft (MSFT) and other players such as Advanced Micro Devices (AMD) and Qualcomm (QCOM) and their peers, are feeling the pain of Trump’s victory, as he has negatively commented on the likes of Apple manufacturing products in China. A large portion of the tech supply chain is located in the Greater China region and surrounding areas, and our brief mention only begins to scratch the surface of the President-elect’s volatile rhetoric on the area leading up to his victory. Participants in the industry are certainly paying close attention to Mr. Trump’s trade plans with the region, the end game very difficult to handicap at the moment.
Not all sectors of the market are taking the surprise election result in a negative light, however. Not surprisingly, prison stocks, Corrections Corp (CXW) and the GEO Group (GEO) are benefiting from the Republican candidate’s victory, as many believe that Trump will push to keep private prisons open. The aerospace and defense industry (ITA) may witness a bump in military spending during Trump’s time in office. The cybersecurity (HACK) arena figures to be a big winner, in particular, “Podcast: Defense Spending and the Explosion of Cyber Crime,” as Trump has called for a review of all US cyber defenses and vulnerabilities. Gun stocks, Smith & Wesson (SWHC) and Sturm, Ruger & Co (RGR), however, have seen declines as a result of decreased near-term demand as potential gun buyers feel less urgency to purchase a firearm due to Trump’s pro-gun policies.
The beleaguered biotech industry (IBB) may be finding its way out of hot water as fears of the government meddling in its affairs have been eased with the defeat of Hillary Clinton, arguably a positive for companies that sport high-priced drugs, including Gilead Sciences (GILD), Merck (MRK), and Vertex (VRTX), among others. Expectations for the repeal of Obamacare reforms mean a shakeup for the healthcare industry in aggregate, as a growing number of healthcare providers have been pulling out of the program in recent years. Congressional Democrats continue to have swagger, however, as even tweets (TWTR) by Bernie Sanders can still send shares of major drug companies tumbling, as was the case more recently with Eli Lilly (LLY) related to its price increase on diabetes-treatment Humalog. We doubt shares of Valeant (VRX will find much reprieve under a new administration, however, in light of its more-troubling business activity. We continue to believe the Healthcare Select Sector SPDR (XLV) is the best way to gain diversified exposure to the secular trend of rising healthcare spending as a percentage of GDP, without taking on too much risk of any one entity’s drug pipeline or possible changes to existing Obamacare legislation.
Crude oil prices (USO) initially dropped following the release of the election results as some expected Trump’s victory to lead to weaker economic growth in an already questionable global economy, which would cause additional pressure on energy-resource demand across the world. However, such weakness was eventually reversed as some of the President-elect’s proposed plans could benefit oil prices, such as his opposition of the US nuclear deal that has allowed Iran to help flood the globe with crude oil. In any case, we continue to believe that the days of $100 per-barrel crude oil prices may be over in the intermediate-term, as around any corner, either US producers or Russia or OPEC will seek to fill any demand void with surplus supply. Exxon Mobil (XOM) and Chevron (CVX) remain the strongest US producers, though much of the E&P industry will still have to scale back capital spending to keep traditional measures of free cash flow in positive territory. We like the Energy Select Sector SPDR (XLE) in that it allows us to avoid dividend “blow-ups” as in the case of concentrating in any one entity, as in what happend to Kinder Morgan (KMI) and ConocoPhillips (COP) recently.
Additionally, major US oil companies are breathing a sigh of relief on hopes for reduced regulation, which has weighed on the industry throughout the Obama administration and may spark an increase in both spending on and the likelihood of the approval of more infrastructure projects, which bodes particularly well for midstream entities. Trump has explicitly supported projects such as the Keystone Pipeline (TRP), though in light of rising interest rates, we continue to cast a cautious eye on the capital-dependent nature of most master limited partnership business models (AMLP), which are prevalent across the energy midstream space in entities such as Energy Transfer Partners (ETP) and Enterprise Products Partners (EPD), for example. Refiners such as Phillips 66 (PSX) and Valero (VLO) may also benefit from a more favorable regulatory environment. Other commodities, such as copper (JJC, CPER), iron and other metals, have caught a bid thanks in part to the potential for production restrictions being lifted in the US and expectations for increased demand related to an uptick in infrastructure projects (IGF). Equipment and infrastructure building companies such as Caterpillar (CAT) and Deere (DE) and engineering and construction companies including Fluor (FLR) and Jacobs Engineering (JEC) are hoping for better times to come.
Perhaps the most interesting aspect of “The Donald’s” proposed changes is his corporate tax plan. He has vowed that no corporation will pay more than a standard 15% tax rate, a significant drop from current levels of 35%, the highest in the world. Trump has also called for a repatriation tax reduction in which trillions dollars in corporate cash sitting overseas could be brought back to the States at just a 10% tax rate. Such a move would benefit major US corporations holding massive amounts of cash overseas, many stocks of which are held in the newsletter portfolios such as Apple, Microsoft, Alphabet (GOOG, GOOGL), and Cisco (CSCO). A reduction in personal taxes for the middle class coupled with job-boosting initiatives could drive consumer spending higher, which could lead to heightened demand for products and services in the struggling consumer discretionary (XLY) and staples (XLP), retail (XRT), and restaurant sectors (BITE). However, there may be no saving grace for department stores such as Sears (SHLD) and J.C. Penney (JCP), which run the risk of obsolescence.
In financial sector (XLF) news, with the 10-year Treasury yield passing the 2% mark for the first time since January 2016, thanks in part to speculation that a Trump Presidency will take the country further into debt, thereby impacting the perceived credit-quality of the US’ sovereign debt (and stimulating selling of Treasuring bonds), banks and money centers now have more wiggle room with respect to net interest margin capture, though the slope of the yield curve will remain the more-critical driver. Regardless, the financial sector had its best trading day since 2011 on November 9, as speculation that a decrease in regulation, key legislative changes, and an inflow of fresh funds--thanks in part to the aforementioned repatriation tax reduction--are all on the way to help fuel financial performance for major banks (KBE). Perhaps most important for the big banking industry, however, is Trump’s critical history on Dodd-Frank, which, if reevaluated, could make the operating environment much easier for banking entities to earn a better return on equity. The thought of JP Morgan (JPM) CEO Jamie Dimon as the next Treasury Secretary is only good news for banking stocks, too.
Other important decisions made across the nation include four states voting to approve minimum wage increases. Arizona, Colorado, and Maine have voted to boost the minimum wage in their states to $12 per hour while the state of Washington approved raising its minimum wage to $13.50. The first three states plan to raise the wage floor gradually, and Washington intends on hitting its target by 2020. The already frustrated restaurant and retail spaces are not welcoming the news, and many operators may find their margins under continuous pressure as a result of rising labor costs. Franchisors such as McDonald’s (MCD), Dunkin’ Brands (DNKN) and DineEquity (DIN) may be better able to handle such adversity as operational risk is pushed primarily to the franchisee, while Walmart (WMT), Target (TGT) and others may not fare as well.
All of this said, we continue to note the uncertainty surrounding a large number of President-elect Trump’s plans, and as a result, we’re not doing much at all in light of the election news. Incremental information will continue to come to light in coming weeks and months as the Trump camp details its plans for the next four years, but the newsletter portfolios continue to be well-positioned under any political environment. Though we may pursue tactical tweaks in the newsletter portfolios in coming months, we think the most valuable takeaway from the far reaching, knee-jerk reaction immediately following the conclusion of the election is that volatility may be back to the markets…in a big way. We’ll be looking to capitalize on any mispricings that may surface. Stay tuned.
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