An Investment Plan for the Next Four Years
Some of the key objectives of the incoming Trump Administration are beginning to become clear, so it is now possible to outline the basis for an investment strategy going forward. Government spending is likely to rise and incentives will be provided for infrastructure and investment spending, all of which should enhance growth prospects. Significant deregulation is also likely. However, such changes should increase labor market scarcity and inflation. Investment portfolios can be adapted to these new economic directions. So, we wish to reduce or minimize exposure to utilities, telecom, consumer staples, REITs, and longer term fixed rate debt. We would increase exposures to financial firms, consumer discretionary, energy, technology, and floating rate and short-term debt securities.
The systematic rise in stock prices and bond yields since the election have been widely noted by analysts, some of whom suggest the market has gotten well ahead of the changes that are likely to make their way through the legislative process, assuming Trump remains committed to them, so some reversal is sure to come. We disagree. Let’s start with the energy sector. There is little doubt that energy policy under Trump will be far more supportive of domestic development than under Obama, who favored reduced exploration and development, curtailed infrastructure construction even when projects had already been approved by government agencies, fought and passed muster in the courts, such as Dakota Access, and disallowed pipeline projects, such as Keystone XL. In the financial industry, Dodd-Frank, the Volcker Rule, designating large firms as SIFIs, and the DoL ruling curtailed lending and financial activity. While none of these is likely to be totally repealed, all are likely to change in a less onerous way to the financial industry. In fact, deregulation is the quickest and easiest way to invigorate growth without increased government spending that might increase the deficit. This suggests that large financial institutions in the bank and insurance sectors should see more growth opportunities and lending terms should ease up.
The broadest, far reaching changes should occur in the tax arena. It is extremely likely that a major push will be made to reduce the corporate tax rate, perhaps to roughly 20% to 25%, along with a possible tax holiday to encourage firms to repatriate profits held overseas. Such changes would instantly enhance corporate profits and commensurately increase stock valuations. It would also obviate the complicated rules put into place to discourage tax inversions, whereby a domestic company acquires a foreign company just to relocate its headquarters out of the U.S. into a more favorable tax regime. American companies would also become more competitive against foreign companies in global markets. Some might even return some jobs to the U.S. and foreign companies would no longer be discouraged by higher taxes from increasing their investments in the U.S. to bring their operations closer to their customers. A reduced corporate tax rate has the further effect of reducing the firm’s cost of capital. All of these factors have positive implications for domestic economic growth, jobs and equity valuations.
A more positive economic outlook implies better performance for domestic, cyclical companies relative to multinational, mature, “safer” companies. But, such broad judgments are not adequate. We need to drill deeper. For example, tech companies are certainly multinational, but their products are also fairly sensitive to the economic cycle. We judge they will be net beneficiaries under the expected changes. REITs are predominantly domestic, but as pass through entities, they pay no taxes so they will be hurt by rising interest rates and receive no benefit from lower tax rates. Utilities and telecom are slow growing sectors that will be helped by lower tax rates, but hurt by rising interest rates. Despite their recent declines, we still find them expensive and quite unattractive.
Collectively, it seems like virtually all of the new policies being contemplated work in the direction of strengthening growth, raising inflation, and increasing interest rates. In our judgment, the economy was already headed in this direction before the election, but the new policies should reinforce these trends, adding additional impetus and undermining all interest rate sensitive investments, including utilities, REITs, telecom, and all long-term bonds, particularly high grade bonds. Investors should starkly reduce their exposure to these sectors, since we expect further weakness in the months and quarters ahead.
The notable wrinkle in this analysis is the possible disruption that a less friendly trade policy might create. On this question, Trump is likely to see significant pushback, so it remains to be seen if he can or wishes to push for major changes.
The foregoing content reflects the opinions of Advisors Capital Management, LLC and is subject to change at any time without notice. Content provided herein is for informational purposes only and should not be used or construed as investment advice or a recommendation regarding the purchase or sale of any security. There is no guarantee that the statements, opinions or forecasts provided herein will prove to be correct. Past performance may not be indicative of future results. Indices are not available for direct investment. Any investor who attempts to mimic the performance of an index would incur fees and expenses which would reduce returns. Securities investing involves risk, including the potential for loss of principal. There is no assurance that any investment plan or strategy will be successful.