January 9, 2017
Invested in TRUMP…. A New Game, In An Old Economy
So much has changed since the election and yet nothing has changed at all. Perception of a better
economy has driven markets in their respective directions. More specifically, stocks not bonds have
benefitted greatly, moving nearly 9.33% versus bonds which have declined nearly 10-20%, depending on
their duration.
Largely what has driven US equities markets, and in this case specifically the Dow Jones, from being
down 800 points the night of the election, to closing 2000 points higher by the end of the year were two
main points.
First, the policy ideas of President-elect coupled with a Republican controlled congress permeated the
markets, and rerated growth expectations. Those ideas are: tax cuts, deregulation, and fiscal spending.
The second point is that this growth rerating has led to very large sector rotation in the market. We saw a
rotation away from crowded, expensive, defensive sectors like: utilities, consumer staples, REITS, and
some large cap tech. Simultaneously capital then moved into cheap, under-owned sectors like: energy,
cyclicals, industrials, financials, construction, & healthcare. Further, the companies who have
outperformed are those whose perceived change in future growth rate under Trump’s policies will be
greater than those who performed well under Obama’s policies.
For example, JP Morgan; was an inexpensive bank and stuck trading in the low $60s, under the prior
administration’s policies. However, the stock quickly moved into the high $80s once the election was
final. There were many instances of stocks perceived future value being greater than today’s, leaving
investors one outcome, buy stocks. The prospect of an improving economy has been validated by a
steepening of the yield curve; where we saw the 10-year treasury yield move from 1.75% to 2.5%. This
sentiment shift was/is very bad for long duration bondholders but also forecasts stronger growth and
inflation down the road which is good for our economy and stocks.
If the above three mentioned policy ideas get through Washington in an orderly way, one can expect to
see roughly the following scenario. In 2017 congress will focus on deregulation and tax reform. In 2018,
the focus will be on fiscal spending largely targeting infrastructure. And in 2019 it will be about getting
reelected. If President-elect stays on course, embedding good policies and uniting Americans we could
see growth rates rise to 2.5-3.5% for the next few years! So, to say the least, after 8 years of a weak
expansion, we may now have an opportunity to feel the effects of positive sentiment and more widely
shared optimism.
While these policy shifts will be enough to spark animal spirits in the economy, there are also other
structural issues our nation continues to face: education, infrastructure, healthcare, transportation, &
housing. We are finally seeing the private sector bring innovative solutions forward that will drive
productivity and efficiencies in these areas. And while we believe that growth in the economy is the most
important focal point today, solving productivity and innovation issues in these areas continues to be a
very integral part of the future success of our country and economy.
On a macro note, elections around the world have signaled change is coming. While appearing
protectionist in nature, we believe citizens of the world want to see economic growth, not war. As such it
is our view that China/Brazil/India/Europe/UK are finally gaining political momentum to drive growth in
their respective countries. This could lead to a 3-5% global GDP growth rate.
While we believe there is a path to sustainable long term economic growth here and abroad - there are
always unknowns that can shake the resolve of investors and markets. More specifically, as markets are
moving on the aforementioned policy ideas and they are more than sufficient to drive the business cycle
another 2-5 years – we are acutely trying to understand what could cause this expansion to last 2 years
versus 5. For the business cycle to last 2 years, rather than 5, it will be because inflation ramps too
quickly forcing policy makers to raise interest rates faster than the economy can handle.
We believe inflation risks are rising for a few reasons. First, crude prices are now expected to be in $50$70 range up from $30-$50. Second, wage pressures are building due to persistent job gains with an
already low unemployment rate. Thirdly, we are seeing housing inflation persist as rental rates increase
in the face of a rising mortgage costs. While higher inflation is not an outright negative, it is something to
carefully monitor as it suffers from the laws of diminishing returns. Thus, policy makers are very
sensitive to inflation rates above the growth rate of the economy, which is currently between 2-2.5%.
From an investment perspective, given the prospects for growth, inflation, and raising rates, our allocation
continues to favor equities over bonds. Today we are overweight: healthcare, technology, industrials,
semiconductors, select energy themes, materials sciences, financials and media. Our selection of sectors
will continue to adjust to the economic environment we are in and the valuation of those sectors. Further,
while our focus continues to be on US companies, we are starting to see attractive opportunities outside of
the US, specifically in: China, Brazil, and Europe.
Finally, if stocks become too expensive we will use options or raise cash.
Thank you for your loyalty and support.
Sincerely,
Vincent Andrews
Managing Director
Matthew Andrews
Portfolio Manager
Enclosure(s)