Cyclical stocks may emerge as winners from the Trump presidency if his campaign promises on infrastructure and regulation come to fruition, says value equity specialists Boston Partners.
US stocks rallied in the fourth quarter after Trump’s election on 8 November, with companies that may benefit from more infrastructure spending or the removal of regulation in the financial and energy industries among the biggest gainers.
Among other campaign promises, Trump has pledged to repeal the Dodd-Frank Wall Street Reform and Consumer Protection Act and the Glass-Steagall Act for banks, both of which came in after the 2008 financial crisis. He also wants to remove climate change-related restrictions facing the energy industry, benefitting the US shale oil and gas industry in particular.
“In the US, the real story for the fourth quarter was the resurgence of value stocks relative to growth stocks, where value beat growth by over 700 basis points on average across all capitalizations,” the firm advised clients in its fourth-quarter performance report and outlook.
“Cyclical stocks did well, led by Energy, Industrials and Materials, all responding to the campaign promises of an infrastructure build-out. Higher rates once again had a negative impact on the bond surrogate sectors, but helped propel the Finance sector of the S&P to a return of 21.1% in the fourth quarter, led by the banking sub-sector, which gained 31.7% – no doubt aided by the potential dismantling/repealing of Dodd-Frank legislation.”
Boston Partners invests in stocks with valuation support – those equities whose share price in the view of the portfolio manager does not reflect the underlying fundamentals of the company, giving the potential for price rises. Times of economic expansion – and rising interest rates – are usually good for value stocks. Conversely, weaker economic periods normally cause a flight into more defensive, less cyclical equities such as Utilities. Weaker periods – and falling interest rates – also make bonds more attractive than equities.
“Earnings and interest rates are the primary drivers of stock prices over time, and the stock market has been leaning on interest rates to keep equities advancing for well over a year,” Boston Partners says in its outlook. “Given that the cyclical, if not the secular, bull market in bonds/rates appears to be over, it is time for earnings to hold up their end of ‘the arrangement’.”
“With consensus expectations for earnings per share growth currently at 12.4% for 2017 and 11.8% for 2018, on paper it would appear (short of a ‘melt-up’ in interest rates and/or inflation) that stock prices can continue on their path upward.”
“But as is always the case, there are risk factors that need to be taken into consideration. For 2017, we see five primary areas that warrant attention, starting with Trump. The question is what the Trump presidency will actually wind up looking like: the campaign pledged turbo-charged fiscal juggernaut, or some type of Congressionally watered down facsimile. Will the market ‘buy the vote, sell the policy’? Only time will tell.”
“Then there is the issue of strong dollar. While additional appreciation is expected this year, a further surge would have a negative impact on commodity prices, multinational corporate earnings and emerging markets.”
“The third potential risk factor is what the Federal Reserve will do this year. Markets are still grappling with the prospect of three rate hikes in 2017, but an overly aggressive Fed (four hikes?) could derail the upward momentum of the market.”
Regarding the oil industry, which figured in Trump’s campaign, Boston Partners believes that the theoretically ideal oil price is between USD 48 and USD 58 dollars a barrel, as this range helps keep the industry in balance. “Under USD 48 strains earnings, balance sheets and debt coverage ratios (and fiscal balances of primary oil producing countries), while over USD 58 has the potential to bring on another supply glut,” the firm says.
“Finally, China still has the potential to upset markets. While the capital exodus appears to have abated and GDP to have stabilized, the world (and in particular emerging markets) needs a smooth transition path towards Chinese reformation.”
Boston Partners says if there is one thing that is clear about a Trump presidency, it is going to be very different from anything we have seen before, making it ever-more important to use active management and a strict bottom-up value-driven approach.
“Overall, we are encouraged that the correlations amongst markets, sectors and individual stocks have started to decouple,” the firm says in its outlook. “This should bode well for active management in general and in particular, for Boston Partners, as our nuanced ‘three-circle approach’ has historically done well in idiosyncratic environments.”
A new era dawns for the United States, but how long will it take newly inaugurated President Trump to change the course of the supertanker that is America? In a series of four articles we analyze the likely economic effects, and the effect on the US companies in which we invest.
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