Sector Watch: Trump election could be a game-changer

“The rebound in the [Toronto Stock Exchange] from the February lows has been accompanied by less concern with energy and emerging markets’ growth. We consider that the strong TSX reflected relief from a dire situation rather than a long-term fundamental improvement.”

Snow believes that Trump’s election is positive for U.S. economic growth. “But it will be a game-changer from a market perspective,” he adds. “It has introduced a lot of uncertainty. We have already seen rising U.S. bond yields and inflation expectations, and an increase in the U.S. dollar against a lot of currencies, especially emerging markets’ currencies.”

Benchmark 10-year U.S. bond yields are up by about 50 basis points to 2.3%, and are exerting similar pressure on 10-year Canada bonds.

“We are still trying to digest this and haven’t changed much in our portfolios. But [Trump’s election] could be a game-changer for asset classes, fundamentals, valuations and [global economic stability],” says Snow.

Although rising bond yields are a genuine concern, the flip side of the story is that a new U.S. administration will focus on fiscal spending and tax cuts. “That [money] will get reinvested in the U.S. economy, which will grow jobs and production,” says Snow. “If we don’t see massive capital and currency flows and trade wars and disruptive trade policies, then tax cuts and fiscal spending should be positive.

“As long as the higher rates are not disruptive,” he adds, “that tends to be in favor of ‘risk’ assets [such as stocks]. You could see valuations expand.”

About 15% of the CI Cambridge fund’s assets under management (AUM) is held in cash, which is a byproduct of the stock-picking process. On a sector basis, 13% of AUM is in industrials, followed by energy (12%), financials (12%), health care (12%) and consumer staples (10%), with smaller weights in sectors such as materials.

About 43% of AUM is in Canadian stocks and income trusts, 35% is in the U.S. and 6% is in international markets.

One top holding in the 45-name CI Cambridge fund is Walgreens Boots Alliance Inc., a dominant U.S.-based retail pharmaceutical player that has undergone a turnaround, with greater emphasis on cosmetics.

Walgreens Boots stock is trading at about US$85.35 ($113.80) a share, or 16.5 times forward earnings. There is no stated target.

Trump’s presidential victory is a key event, says Robert Taylor, Toronto-based senior vice president at Canoe Financial LP and portfolio manager of Canoe Equity Class Fund. He says that Trump’s election heralds significant economic stimulus and many companies will benefit from corporate tax relief.

“I believe that 2016 was a transition year,” says Taylor. “We’re coming from a global downturn for the past couple of years and are heading into a global recovery in 2017. The big story is a change in [investment markets’] leadership from defensive sectors to cyclical ones. But the sector rotation has been well underway, even before the presidential election. In fact, [the change] was going to happen regardless of who won. The market was moving in that direction for about six months.”

Taylor says that the collapse in commodity prices and drops in interest rates and global economic growth in 2014-15 saw the market rotate into the consumer staples, telecommunications and utilities sectors. “But in 2016, cyclicals, such as energy, and U.S. financials, which were beaten down the most, began to assume leadership.”

Interest rates bottomed this past autumn, Taylor adds, and the rise in 10-year U.S. bond yields was a significant breakthrough: “In the past six months, people have been taking profits in the interest-sensitive sectors and moved into cyclical exposures. What will drive this? Better global growth. [This trend] should accelerate, as should corporate earnings.”

He adds that Trump’s policies of fiscal stimulus and tax cuts will provide a tailwind for economies and markets. The key risk, Taylor says, is a policy mistake by the U.S. Federal Reserve Board, which may raise interest rates faster than anticipated. “If rates move higher too quickly, that could choke off the economy and we could move into recession,” says Taylor.

As for key commodities such as crude oil, Taylor adds, the risk is to the upside, as the Organization of Petroleum Exporting Countries plans to cut production and let prices rise.

“When we look out to the next year or so,” he says, “we’re still in recovery mode in energy markets. There is more upside left. I would not be surprised to see oil [trading at] US$60 to US$80 [a barrel] in the next 12 to 18 months.”

About 56% of the Canoe fund’s AUM is in Canada, 37% is in the U.S. and about 7% is in cash. About 26% of AUM is in financial services, 20% is in energy and 11% is in industrials, with smaller weightings in sectors such as technology.

One top holding is Wells Fargo & Co., a so-called “super-regional” U.S. bank. “[Wells Fargo] should be a big beneficiary of a steeper yield curve and lower tax rates,” says Taylor. “And the stock is cheap relative to its peers.”

Wells Fargo stock is trading at about US$52 ($70) a share (12.8 times earnings). Taylor has a 12-18 month target of US$60 a share.

Trump’s election is a game-changer, agrees Mark Schmehl, portfolio manager at Toronto-based Fidelity Investments ULC and portfolio manager of Fidelity Canadian Growth Company Fund.

“[The election] was a radical change,” he says. “The fact that the Republicans swept all three branches of government is what made the market move straight up. When the market prices in a variety of [probable] market-friendly initiatives – lower taxes and less regulation – the market [says] this is ‘great and stimulative’.”

Schmehl says that U.S. banks and financials, hurt by regulation and ultra-low interest rates, stand to gain: “The Democrats have gone after [the banks] with ever-increasing regulations. The financial system, globally, has paid US$300 billion in fines and penalties over the past seven years to governments. That’s a lot of capital.” This pressure will start to ease, he adds, and the U.S. economy will benefit because access to credit will improve.

On the losing side, Schmehl argues, so-called “bond proxies” such as consumer staples and real estate investment trusts will be abandoned by investors.

“The market is pricing in more inflation and higher interest rates, which will wipe out the safer, boring companies,” he says.” There’s no reason why someone should pay 20 times earnings for utilities – it provides zero value.” Schmehl adds: “This is good for the market because it will send capital to companies that need it to grow.”

As for risks on the downside, Schmehl says, the yield curve might steepen too quickly or markets could be rattled by an exogenous shock such as a sudden geopolitical crisis. “Trying to make a call on the Fed is a fool’s game. That’s why I run fully invested. Timing markets is impossible.”

Schmehl is a bottom-up, growth investor. He has allocated about 35% of the Fidelity fund’s AUM to technology (including 13% of AUM in so-called artificial intelligence companies), 14% to health care, 11% to energy, 11% to materials and 9% to consumer discretionary. There are smaller holdings in sectors such as financials.

From a geographical perspective, the fund’s AUM is split evenly between Canadian and U.S. holdings.

One top position in the 100-name Fidelity fund is Shopify Inc., the Canadian online-shopping firm. “[Shopify has] great people and a great product. The firm will continue to grow,” says Schmehl, noting that revenue doubled in the past year.

Shopify stock trades at about $56.30 a share, but its price/earnings multiple is sky-high because the firm has yet to be profitable. There is no stated target.

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