Markets have been flipped on their head following Trump’s surprise victory.
For equity investors specifically, one needs to look "under the hood" – the overall S&P 500’s index returns hide the fact that some sectors have done well at the expense of others.
The Financial Select Sector SPDR (NYSE:XLF) is up 18%, trouncing the S&P return of 9%. Former favorites such as tech and consumer staples (Technology Select Sector SPDR (NYSE:XLK) and Consumer Staples Select Sector SPDR (NYSE:XLP)) have underperformed, returning 7% and 2% respectively. Two months after the election, we can now see what the “Trump Trade” consists of – and I believe the pendulum has swung too far in one direction.
Post-election, investors began rotating out of the aforementioned sectors - technology stocks and other “yieldy” plays like consumer staples, REITs and utilities. These funds have been plowed into formerly maligned sectors like banks and energy.
The speed at which this rotation has taken place - the market fully buying into Trump’s incoming proposals - is noteworthy, but not surprising to students of financial history.
When President Barack Obama initially took office and introduced stimulus packages in 2009, the market quickly priced in these potential effects – only to be later let down as inflation failed to rear its head.
History doesn’t repeat, but it certainly rhymes, and the market is too sanguine on Trump’s policy proposals.
It is worth noting that markets are ‘reflexive’ in nature, to borrow a term from George Soros. If a narrative takes hold among enough market participants, it can become self-fulfilling.
This is seen most often in market sell-offs; selling begets selling and a sustained market decline leads to a loss of faith in the economy. Consumer spending dries up and the business cycle tips into recession.
The inverse of this scenario could happen here – contagious optimism leads to increased spending (both by individuals and businesses) and we enter a multi-year stretch of 3-4% inflation and GDP growth.
We have seen a handful of money managers – from Ray Dalio to Bill Gross to Jeff Gundlach – claim this is a seminal turning point in markets and that the process is already underway.
I believe they are wrong for multiple reasons.
- The tax environment is different from the 1970’s. Reagan’s tax cuts were off a much higher base – the top marginal tax rate was 70%, which he lowered to 28% by 1986.
- Debt to GDP is higher today, meaning that it takes longer for the effect of lower taxes to filter their way through the economy.
- Demographics are a headwind as U.S. population growth slows. The fourth factor – and in my opinion most important – is the deflationary nature of technological progress. Companies like Amazon (NASDAQ:AMZN), Google (NASDAQ:GOOGL) and Facebook (NASDAQ:FB) shrink the size of markets they enter, increasing efficiency and lowering margins while capturing all the value for themselves. This trend is accelerating as these firms continue gaining share and will keep a lid on GDP growth.
What is the best way for an equity investor to express these views, which run contrary to the Trump Trade’s assumptions?
In my opinion, there are two sectors that have been sold post-election without regard for fundamentals – tech and consumer staples. Many asset managers have used these as a source of funds, leading to underperformance despite many of Trump’s policies (such as repatriation) serving as a boon for tech companies.
The picture for consumer staples is slightly murkier due to the dollar strength – multinationals will be hurt by the dual headwinds of FX translation and lower sales in foreign countries as consumers switch to locally-produced goods.
The onus to switch to domestic labor rather than outsourcing to China could crimp margins as well.
However, many of these stocks also sport 3-5% dividend yields and should find buyers again if the low-return environment of the past eight years continues.
Going against the prevailing trend is never easy.
However, famous investor Howard Marks says it best: Following the beliefs of the herd will give you average performance in the long run. The herd has offered up blue chip sectors – mega-cap tech and consumer staples – at a discount, and the time to take advantage is now.