The media has credited Trump for the rally in yields and the recent swoon in the equity market.  The argument goes that Trump’s policies notably with higher spending, lower taxes and less regulation will be positive for growth and inflation.

Since being elected president, the market has wiped over 1 trillion of dollars in fixed income value and caused equities to soar.  Such a swing surely isn’t attributable to Trump.  It doesn’t add up.

Beginning in February this year, the markets have ignored improving fundamentals pointing to stronger economic and earnings growth and higher rates ahead.  Investors decisions have been framed by recency bias reinforced by geopolitical events (Brexit, impending US elections, etc).   The market has ignored improvements in  emerging market economic data, stronger inflation, higher wages and better housing starts – which have all been pointing to an improving economy.
trump-broke-fixed-income

Another critical element in this rotation are earnings.  For two years earnings have been flat at a time when valuations have been broadly full.   This hasn’t provided incentive to increase exposure.  Again here, S&P500 earnings have risen by 7.9% in Q3’16 (ex-energy).  Moreover earning growth are expected to continue to improve next quarter and in 2017 where they are expected to grow by more than 11%. Similarly European earnings turn up in Q4 and are expected to report earnings above 12% in 2017.

Despite these improving fundamentals, the fixed income market remained constrained with yields trending near historic lows. Investors who had earned their best 2016 returns through fixed income gains simply haven’t felt compelled to adjust their allocation.

Trump’s surprise victory was the straw that broke the fixed income camels back. Investors were expecting a Clinton win and along with it, a continuation of the muddle along government economic policies. We’ve very likely witnessed the lowest rates in history.  Within a week of Trump’s win, despite being vilified as the leader of the alt-right, he is also seen as a Regan-esqe Republican who will spur growth, lower taxes, lower regulation and which will lead America back to global economic strength.

Portfolio Positioning for a Trump Economy

Go long equities, long industrial commodities (energy, steel and copper) and reduce fixed income.  Within equities, go long Value and rotate out of Growth.  From a regional perspective US, Europe and Asian equities all offer opportunity.

We’ve been advocating for investors to do this since the summer.  Expect to see further downside in many of the high dividend paying stocks which are trading off their dividend yield with valuations that are totally disconnected from economic fundamentals.  Take Coca-Cola for example which trades at a P/E of 25x and grows earnings at a meager 5%.  Investors bid up shares in the company for it’s 3.3% dividend.  Colgate trades at a P/E of 43x and Clorox at over 23x.

Steer clear of large areas of technology where investors chased growth regardless of price.  Bubbles exist in the likes of Netflix and Amazon.  Public equities in this area are at risk but investors hold liquid securities.  Technology private equity investments are even worse. ‘Unicorns’ such as Uber, Airbnb and Snapchat are being financed at valuations that harken back to the internet bubble and additionally where investors can’t exit.

We’re positive on European equities.  Europe will benefit from the recent fall in the Euro/Dollar.  Furthermore, improving economies in both the US and emerging markets will be stimulative for demand in Europe.  Valuations and massive underweights by investors add to our optimism on Europe equities.

Will a failed Italian referendum cause Airbus to sell less planes? If Le Pen wins the French elections next year, will SAP sales be affected?  We don’t think so.  Herein lies the opportunity, investors are scared of ‘the other’ candidate winning elections across Europe, allowing us to buy companies at highly attractive prices regardless of who wins.

We also believe that indexing will underperform in the years ahead as market breadth improves

We see opportunities in those parts of the market which will benefit from an improving economy.  At a sector level financials, industrials, consumer discretionary and the energy sectors stand out.

Most investors have ignored the improving fundamentals which will continue to improve going forward, separate from what Trump might do.  Earnings in the US and Europe are expected to keep rising in 2017 and the deflationary scare of mid-2016 is over.  Quite the opposite in fact, inflation is at or near it’s 2% target in the US and inflation in  Europe has started to trend higher.  Recent comments by Draghi who’s signaled plans to maintain a highly accommodative stance, will result in a lower Euro, higher inflation and better sales for European companies.

Fixed income exposure is falling and should continue to as rates start their march higher.

Trump has ambitious plans on the economic front.  His ability to achieve lower taxes, higher spending and an easier regulatory environment are just ideas – ideas which spooked investors into repositioning but are pre-mature to fully discount.  James Carville said it best.  The noted Democratic strategist coined the term, ‘it’s the economy stupid’.  The economy is improving which argues for a rotation to equities, and within equities to go long Value and rotate out of Growth.

You can also find out more about these exceptional managers and the associated strategies on our website at www.anassa.ch.