Since we have been positive on what the market is deeming to be “Trump Sectors” all year, we are growing increasingly worried about the “too much too soon phenomenon.”
When all the big macro guys who have been bearish for years start getting bullish just because we get a new president we start seeing red flags.
We have always said this bull market would end on a capitulation of the bears getting out of treasuries, which has been an easy play for several years and allowed them to be bearish but still make money—this unwind will take years and plenty of ways to make money.
While Trump has been talking up infrastructure spending we believe this will be a hard thing to get done early on in his presidency because of already high debt to GDP ratios and we believe the market has already done a good job pricing this in with the run-up in basic material and industrial plays.
Since the election, the moves in financial assets have been incredible as market participants show just how offside they had become while betting against a Trump presidency
What is equally as shocking is the fact that the market seems to want to price in an entire four-year Trump presidency in just a week or two.
Any stocks having to do with infrastructure spending have taken off regardless of underlying fundamentals in the hopes that a large fiscal stimulus plan is coming that will have us rebuilding all roads and bridges. Inflation expectations have sizzled as the yield curve has steepened and financial markets warm to the likelihood of a rate hike in December.
Trump wants to give a shot of adrenaline to the economy by fashioning Reagan like policies of fiscal spending through tax cuts and public project spending. But the problem for the Trump administration is going to be the fact he is inheriting an economy in a late cycle expansion that has a debt-to-GDP ratio of around 100 percent and the beginning of what figures to be a rising rate cycle.
When Reagan took office, he inherited a struggling economy just coming out of recession, with debt-to-GDP under 40 percent and a rate cycle that had just begun to top and fall.
These inconvenient truths will make it harder for an immediate massive fiscal stimulus plan to give the economy its jolt and thus comes the worry of some forgotten sectors in the stock market getting a little ahead of themselves, giddy for some attention.
Luckily for Trump, there is plenty of room to help businesses on the regulation front and we believe certain types of policy rollbacks will have the biggest and most immediate impacts in the stock market.
We believe the safest way to trade off a Trump presidency will be deregulation trades specifically in the financials and small caps.
Banks have been trading at depressed price to book ratios for years as the financial crisis hit them once and then new government regulations have kept them down on the mat for years. We look for an upward adjustment in the PB Ratio going forward.
Small caps just broke out to new highs for the first time since June of 2015 because fewer regulations for business, which means that it will be easier to compete with large multinational companies.
Emerging markets also continue to be one of our favorite areas and should benefit overall from a Trump presidency. We are already seeing the sector hold up in the face of fierce dollar moves, which is exceedingly bullish.
Emerging markets are a way to play an under allocated area that should benefit from infrastructure spending, as well as deregulation in the financial world, as more money finds a home in some of the fastest growing areas in the world.
In the fixed income world, high-yield should outperform investment grade as yield sensitive gets hit with oncoming inflation fears, but credit sensitive benefits due to the deregulation in the financial sector making more money available to refinance outstanding loans.
The most obvious place for deregulation to matter is in the financials which have been choked back by things such as stifling reserve ratio requirements and the Dodd Frank Act.
While the financials have already had a great run since Trump became president, we continue to believe there is more upside left as regulations soften and massive amounts of commercial real estate put on floating lines of credit must be refinanced into more permanent loans.
Another less obvious martyr of a Trump presidency on the regulation front should be the DOL’s Fiduciary Rule which was met with loud complaints from both houses of congress but was signed into law anyway. If the Fiduciary Rule is indeed rolled back, then broker dealers like LPL Financial (Ticker: LPLA) and Ameriprise Financial (Ticker: AMP) should immediately benefit because their brokers will again be able to use the commissionable products that they were being forced to stop using which will result in increased earnings for each.
Another beneficiary of an abolished Fiduciary Rule will be the mutual fund industry, as commissionable shares will once again be available for use in retirement plans and IRAs—direct benefactors would be companies like Franklin Resources (Ticker: BEN), Alliance Bernstein (Ticker: AB) and Janus (Ticker: JNS).
The other reason we prefer financials is because of the surge in LIBOR to the highest levels since the financial crisis—not only does this obviously help banks, as the interest they get on loans tied to LIBOR increases—but it also helps more obscure pockets of the financial sector.
Two more obscure ways to play rising rates are Main Street Capital (Ticker: MAIN) and Paychex (Ticker: PAYX). Main Street lends to private companies and most of their loans are tied to LIBOR—meaning if LIBOR rises they receive more interest income—which give them lots of earnings upside in a rising rate environment.
Paychex is a payroll processor who receives wages from clients which they hold for a short period and then payout to employees; in a rising rate environment, all interest received on these short-term deposits go directly to the bottom line and requires no extra work on Paychex’s end.
Finally, mortgage servicers are a direct beneficiary of rising rates because as mortgage rates rise, the number of people refinancing or prepaying their mortgage falls, causing Mortgage Servicing Rights to become more valuable. We continue to believe New Residential Investment Corporation (Ticker: NRZ) offers great upside as they continue to increase their excess MSR portfolio and have now become licensed in all fifty states to own MSRs outright without a partner; they are doing this right, at what we believe to be the turn of the cycle, with a solid balance sheet ready to expand in a sector that has left many of their competitors in shambles after many years of a falling rate environment.
Securities and advisory services offered through Centaurus Financial, Inc., member FINRA and SIPC, a registered investment advisor. Centaurus Financial, Inc. and First Franklin Financial Services are not affiliated companies. This presentation is for educational purposes only and is not intended for investment advice or a solicitation of services.
Brett Ewing and