Less than a month into his presidency, Donald Trump is already making some of the sweeping changes he promised to bring to Washington DC, providing a lift for stock prices across a variety of market sectors and industries.
Two of his pro-growth policies in particular—deregulation and tax reform—are spawning high expectations for continued growth in the equities market.
We see both opportunities and risks in this new environment.
Pros: Companies could benefit from tax reform and regulatory relief
In general, four types of companies have seen the most impressive price appreciation since the November elections:
Cons: Valuations appear full, sources of cheap financing are plentiful
In our view, there are several factors that could offset some of the benefits mentioned above. Much of the market’s newfound optimism appears to be predicated on the hope that the President’s pro-growth policies will encourage individuals and corporations to loosen their purse strings and start spending more freely, creating a virtuous cycle of business expansion and economic growth. So these factors are important to consider:
Is the market’s momentum sustainable? The answer depends largely on whether or not President Trump can deliver on his campaign platform, as well as the continued strength of corporate earnings (CHART).
In 2015 and 2016, stock prices appreciated despite the fact that earnings fell for six consecutive quarters. The Fed’s accommodative monetary policies provided businesses with cheap financing, which investors perceived as a “safety net” for stock prices. But in 2017, that safety net could be removed if the Fed raises rates as expected.
Still, P/E multiples in some areas of the market have approached the top of their historic range.
The bottom line is that we think a market correction is possible within the next several months if presidential policies fall short of expectations, or if corporate earnings lose their momentum. We never want to chase performance by investing when valuations appear full or when sectors are rallying based on investor sentiment. But a brief pullback in the market could provide us with an opportunity to increase our exposure to certain holdings at valuations we consider more reasonable.
It is also worth pointing out that our investment philosophy emphasizes growth at a reasonable price, whether the market is rallying or retreating. In the first half of 2016, for example, fears of a global recession and deflation pushed investors into “safe haven” sectors known for income and capital preservation, driving valuations to levels that were difficult to justify given our expectations for slow and steady economic growth. Our discipline was rewarded when the economy strengthened and markets re-adjusted during the second half of the year.
While we are always on the lookout for new investment opportunities, including stocks that might benefit from the current economic cycle, we prefer longer-term investment themes that appear less sensitive to the economy’s ups and downs. Today, those high-conviction themes include cloud-based technologies, innovation in the healthcare industry and consumption patterns driven by millennials.
CHART: Earnings Are Expected to Improve in 2017
Source: FactSet as of 2/10/17.
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