Download 50 days of Pres. Trump – can the US equity rally

CIO Office | Q2 2017
50 days of Pres. Trump – can the US equity rally continue?
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The US equity indices have performed strongly since the US equity elections, belying high valuations
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Disappointment with Pres. Trump’s ability to push through reforms, is now causing a reversal of gains
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Expectations of high earnings growth in 2017 from US corporates, led by energy and financials
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Better economic growth and a gradual and continued pace of Fed tightening are key catalysts
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Tax reform implementation and its timing crucial to maintain US equity gains
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European and Emerging markets with higher growth and lower valuations appear more attractive
In President Trump’s first 50 days in office the S&P 500 has gained 4.5% (+10% since the US election), a
performance similar to Barack Obama’s and Bill Clinton’s first 50 days in office, but beating the track record of other
Republican Presidents. The rally has since stalled, as the failure to transform the US healthcare system creates
doubts over President Trump’s ability to push through tax reform. Market expectations of lower corporate taxes
and the ensuing gains to company profits, along with upgrades to analysts’ corporate earning upgrades, have been the
mainstay of the recent US rally.
President Trump lost some credibility by not managing to repeal Obamacare - the healthcare law signed by Barack
Obama in 2010. The proposed healthcare bill did not gain support even with the Republicans, as it would have led to
24 million Americans losing their health insurance and higher premiums for the elderly. President Trump has stated he
plans to now focus on tax and trade reforms and growth of the manufacturing sector. However, the replacement health
bill would have freed government funds making it easier to get support for the planned tax reforms.
Investors continue to buy US stocks, betting on a strengthening economy and believing in a post-election
narrative that deregulation, tax cuts, trade tariffs and infrastructure spending will boost GDP growth. Growth
stocks, led by the technology sector, have performed well, as investors rushed to discount the likelihood that the sector
would post stronger earnings in times of a prospering economy. We expect the focus of investors to shift to value, as
growth now looks expensive.
Chart 1: S&P 500 Performance: 50 days in office, the last 10 US Presidents
10%
8%
5%
4.7%
4.5%
4.5%
4.5%
2.5%
2.2%
2.1%
Ronal
Regan
George
HW
Bush
George
W Bush
3%
Ronal
Regan
George
W Bush
Barack
Obama
0%
-3%
Bill
Clinton
Barack
Obama
Bill
Clinton
Donald
Trump
(1.3%)
-5%
-8%
(8.1%)
-10%
-13%
1993
2013
1997
2017
1985
1989
2005
1981
2001
(10.4%)
2009
Source: Morningstar, Bloomberg
Are we seeing the beginning of a reversal of the Trump rally? US equity funds saw their largest outflows in the last
two weeks of March since the week of Brexit. However, inflows into US equities since the US elections are still a hefty
$90bn and analysts estimate that full year 2017 will see inflows of $200bn (including buybacks).
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Investors have begun doubting Pres. Trump’s ability to push through the crucial tax reform, lowering taxes for
US corporates. In March there was shift to large cap (healthcare, technology and utilities) and a rotation out of small
cap with the Russell 2000 seen as a barometer of the US economy halting its meteoric rise (+16% since the election)
All the major US equity indices recorded new highs in Pres. Trumps first 50 days. The S&P 500 crossed 2400 on 1 st
March, with the Nasdaq Index too trading over 5900 for the first time. The Dow Jones Index is currently trading well over
20,000 doubling since 2010. Valuations however remain peaky, raising concerns on the sustainability of this rally,
with Shiller’s Cape (the cyclically adjusted price earning) multiple at a two-decade high (29X ten year earnings compared
to an average of 16X). US equity market valuations are at their highest level since 2004 at 18.3X forward price to
earnings for the S&P500
However, volatility is close to historical lows, in what is now an eight-year bull market. The VIX (CBOE Volatility)
Index at 12.4, has posted its second-lowest quarterly average on record. The S&P500 has traded down more than 1%
on only one day since the election. The infamous ‘Trump tweets’ have created “noise and bluster”, but economic data
have been getting better and confidence indicators are strong, supporting the market’s climb.
Lofty valuations are causing a shift in investor preference and US equities are now losing out:
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European equities saw inflows in the last week of March after nearly a year of outflows and have outperformed
the U.S. in Q1
Emerging market equities were up +16% in Q1, as fears of a stronger dollar and trade embargoes faded
The election boosted returns for those sectors linked to Mr. Trump’s policies to boost US growth, cut corporate
taxes, restrict trade and reduce regulation. A reversal of some popular postelection trades is now taking place with
investors pulling back from banks and infrastructure companies. The financial sector fell 2.9% in March, while industrials
declined 0.8%.
Chart 2: Sector performance post-election
Chart 3: Sector performance post inauguration
Source: Rebased to 100, Bloomberg
We still like US banks, our favored sector since 3rd quarter 2016, as interest rate increases are accretive to the bottom
line. An increase of 25bps translates into $250mn of additional earnings for the large US banks. The proposed
modification of the Dodd Frank Act would ease the way banks currently conduct business. Though the banking index is
+38% since 1st October, valuations at trailing 15X price to earnings are below the broader US market, giving more room
for upside.
The most obvious winners of the infrastructure and “buy American” push by Mr. Trump were suppliers of steel
and other materials needed if roads, bridges and a border wall are to be built. The postelection bounce has faded, and
U.S. steel stocks, while up, are no longer ahead of European or Japanese steel makers.
The tech sector up 7.4% since the inauguration, is also the best performing sector in Q1 +12.6%. The technology
companies promise exponential growth as industries increasingly use artificial intelligence and big data for analytics and
the cloud for storage.
Managed Healthcare recently got a boost as Pres. Trump failed to repeal Obamacare. The healthcare sector is +
8.6% since the inauguration. Healthcare companies had been underperforming the broader market and are now playing
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catch up. Though high margins and innovation ensure profits and healthcare is a defensive sector, we expect pricing
power to be curtailed capping gains.
The small cap Russell 2000 index is up 14.2% since the November 8 election, however small caps have recently
given up some of their gains. The strong run of small caps was built on expectations that more domestically orientated
companies would thrive in an environment marked by higher economic growth and protectionist trade policies. These
protectionist policies are now taking a back seat and the dollar has given back about half its gains since the election.
Chart 4: The Russell 2000 small cap Index gives up its gains
Source: Bloomberg
The buoyancy of the US equity market will increasingly depend on US companies being able to meet earning
expectations. Consensus estimates are for companies in the S&P 500 to grow Q1 profits by 9 to 10%, year on year
driven by revenue growth, flat margins and buybacks. We see this as the most important driver for US equity markets
as earnings growth has proven to be the most successful approach to forecast price appreciation in equity markets.
If earning growth expectations are met it would be a third straight quarter of earnings growth, after five quarters
of declining profits. Energy companies are expected to grow earnings exponentially (coming from losses in Q1 2016),
followed by Technology +16.5%, Financials +16.2%, and Materials +13.7%. In Q4 2016 earnings for the S&P 500 grew
by +6.1%. Technology Financials, and Utilities recorded the highest growth rates.
Announced buybacks for 2017 led largely by technology, financials and consumer discretionary companies are c.
$500bn providing 1-2% of EPS upside. EPS would be further boosted by any tax amnesty as a large number of
companies that keep cash overseas, estimated at $ 1 trillion would be repatriated leading to further buybacks. In 2016
83% of net income was distributed as buybacks and dividends.
Corporate tax cuts: The effective tax rate for companies in the S&P 500 has been stable at 27%, at a 35% statutory
federal tax rate. A decline of 8 to 9%% in the effective tax rate to 18% would add correspondingly to EPS growth.
Multinationals (pharma, tech and capital goods) have a lower effective rate while domestic companies (retail, utilities,
media) a higher rate. However, as faith in tax reform dwindles high-tax stocks, which had been outperforming,
have given up their gains and are back to pre-election levels illustrating the markets’ lack of confidence in any
tax cuts in the near future.
Tightening cycles: The Fed is expected to raise rates at least twice more in 2017. Stocks typically record gains 15
months into a tightening cycle, as is true of the current cycle which began in December 2015 with US equities up
16% since then. This is contrary to popular belief that higher rates are negative for share prices. The pace of tightening
will have the more important impact on the chances of further gains rather than the absolute interest rate hikes.
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U.S. growth: Economic data has been good, U.S. employers added jobs above expectations in January and February,
with the unemployment rate falling to 4.7% and wages growing 2.8%. Goods-producing industries, which include mining,
construction and manufacturing, added 95,000 jobs in February, the most since 2000. Inflation is close to the 2%
targeted rate. The idea that the U.S. was back on a high growth trajectory was reflected in U.S. stock market
outperformance in Jan and Feb.
Immigration curbs may increase labour costs for US companies however Pres. Trump is receiving some
support. Samsung will invest $300 million in expanding U.S. production facilities, creating around 500 jobs. Exxon will
spend $20 billion over 10 years on 11 plants along the Gulf Coast, creating 45,000 jobs for American workers. Fiat
Chrysler is set to invest $1 billion in two factories in Toledo and Detroit, an expansion that will create 2,000 jobs.
As the year progresses and the expected reforms that would aid US corporate profitability get delayed the market would
naturally correct to more reasonable valuations. Additionally, foreign policy direction is creating political risk which
could take volatility up very sharply. Anywhere between 5 to 10% downside could be expected
The Trump trade is over, and an improving economy and reasonable corporate earnings growth are required
to maintain the US equity markets at current levels. . What’s crucial for US equity markets to retain their gains?
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An improving economy
Tax reform, which is Pres. Trumps’ get-out-of-jail card
Corporate earnings growth leading to lower valuations
A gradual fed tightening cycle
Our focus remains on buying quality stocks, rather than buying the overall market. Invest in companies that are
continually evolving and recreating their businesses, ensuring long-term profit and survival in a highly competitive world.
These companies are adopting disruptive technologies and are exploring new markets ensuring high return on equity.
What sectors would we be look to add to in the US on a correction?
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Financials, as rate hikes are profit accretive and valuations are still not stretched
Technology as this is one sector where growth is consistently above market
Oil producers, as the sector is oversold and oil seems to have found a floor
We have kept faith with infrastructure plays for a little later in the year, though U.S. bridges and roads need refurbishment
and the Democrats would support this Bill.
Anita Gupta
Head of Equity Strategy -CIO Off
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