MARKET COMMENTARY

Trump and the Tech Sector: A Frosty Relationship Begins to Thaw

12.27.2016

It's no secret that Donald Trump and Silicon Valley were not the closest of friends during the 2016 presidential campaign: As Trump accused the industry of shipping American jobs overseas, the tech industry warned that Trump would be a "disaster" for innovation. After Election Day, fears of a trade war with China contributed to a modest selloff in tech stocks.

However, there are indications that this relationship could be improving and that the shift away from tech stocks might be losing steam. Last week, the President-elect told the industry's top executives that his administration is "here to help." Trump's positions on immigration and China also appear to be softening, and technology stock prices have bounced back above their pre-election average.

In this Q&A, portfolio manager Joseph C. Portillo offers his perspective on Trump's relationship with Silicon Valley, how it has influenced valuations, and what a Trump administration might mean for tech investors in 2017 and beyond. Joe is a 24-year veteran of Fiduciary Trust and works in our downtown Los Angeles office.

Q: Why did we see a pullback in tech stocks after Trump won the election?

JOSEPH:  In the days after the election, concerns about Trump restricting free trade were outweighing the potential benefits his pro-growth policies. But there were other factors weighing on the tech sector as well: Many tech companies have seen strong gains in 2016. For example, companies that make semiconductors and semiconductor-related equipment were up almost 30% through the end of November. So when Trump was elected investors saw an opportunity to take profits from tech stocks and use them to rotate into other sectors where the benefits of a Trump administration appeared more obvious; like industrials, energy and financial services.

Q: How long will this rotation last?

JOSEPH: Timing of market momentum and investor sentiment is challenging. We think it is much too early to tell how much of Trump's campaign rhetoric will become policies that fundamentally change businesses and the economy. But we are already starting to see signs that the rotation could be easing. The tech sector has returned 3.1% since Election Day and 16% year-to-date.1

Despite a Post-Election Stumble, the Tech Sector Has Returned 16% Year-To-Date Sector returns through December 20, 2016.

Q: Has your approach to tech sector investing changed since the elections?
JOSEPH:  We are a bit more cautious about some parts of the sector, but we are also looking for buying opportunities among a select group of stocks. The semiconductor industry still has strong fundamentals and we believe that demand for semiconductors and software should remain strong as cloud computing gains critical mass. The reason we are more cautious about semiconductors is that the category saw a significant run-up in prices this year. Valuations are still within a range we would consider reasonable but there is more uncertainty about the potential for further price appreciation. A correction in the tech sector could present buying opportunities in companies we view as potential long-term secular winners.

Q: Do any of Trump's proposals create growth opportunities for tech companies?

JOSEPH: We see several interesting possibilities. The first is Trump's commitment to modernizing the US transportation infrastructure, which is impossible to do without spending money on software and computer systems. Infrastructure spending won't solve the commoditization issues faced by hardware manufacturers, but it might provide a modest lift for cloud computing.

The US government already spends a lot of money on technology in general and it spends more money on cloud computing services than most people realize. According to IDC Research, about 8.5% of all federal government IT spending in fiscal year 2016 (which ended on September 30) went to cloud services, up from 5% the previous year. If Trump is the businessman he claims to be, he will quickly recognize the cost efficiencies offered by cloud platforms and look for opportunities to incorporate them into the government's transportation infrastructure projects in areas such as traffic control, building and material management systems, and logistics.
 
Another possibility is that Trump could be successful in eliminating or reducing government regulations, making it easier for tech firms to make acquisitions and merge with one another. The repeal of the FCC's net neutrality rules could free up internet providers to charge a premium for faster data delivery, giving certain customers access to the "fast lane" of the internet.

Trump also has expressed concerns about internet security, which could benefit companies that operate in that space. In the financial services industry, deregulation could benefit payment-processing companies.

Q: How would the repatriation of cash held overseas affect tech firms?

JOSEPH: Trump and the GOP are both calling for tax incentives that would encourage American firms to bring back cash and other assets held overseas, a category the IRS refers to as "unremitted foreign earnings." According to Strategas Research Group, the 10 public tech companies with the largest unremitted foreign earnings have $573 billion worth of assets that could be brought back into the United States.

It is still too early to tell where Trump and Congress will end up on the repatriation issue, but Trump has proposed a tax holiday that would offer a one-time tax rate of 10% on repatriated assets. If that happens, we would expect to see an acceleration of share buyback activity in the tech sector, the payment of special dividends to shareholders, or possibly an increase in mergers and acquisitions. On the other hand, there could be strings attached to any repatriation tax breaks approved by Congress.

Companies could be prohibited from using repatriated funds to pay dividends, or they might be required to reinvest a portion of the repatriated funds in infrastructure bonds. These discussions are all very preliminary, so we will be keeping a close eye on Washington over the weeks and months ahead.

Q: Can Trump force tech firms to bring manufacturing jobs back to the US?

JOSEPH: There are things he could do to pressure tech firms into bringing jobs back to the US, but it simply would not be cost-competitive for those companies to pay American wages. Trump's proposed crackdown on immigration, such as restricting H-1B visas, would also be problematic for the software industry because there just aren't enough skilled, trained software engineers in the US. These policy proposals are still in the development stage, and his positions on these issues appear to be softening, so we are watching them carefully.

Q: Are you concerned about Trump's 'America First' protectionist views?

JOSEPH: If his rhetoric were to escalate, the fear is that it could lead to tariffs on Chinese imports and a trade war between the US and China, which would be very bad for the tech sector and many other multinational companies across sectors.

The fact is that many American tech firms are international companies that are competing for market share against companies based in China and India, some of which already manufacture and sell fairly sophisticated, high-quality products. In essence, a trade war between the US and China could mean ceding the tech market to the Chinese. We are hopeful that this will not happen.

Q: Have you seen any recent advancements in technology that are particularly noteworthy?

JOSEPH: Actually, we have seen some interesting developments in the techniques and equipment used to manufacture semiconductor chips. Although manufacturers have already reduced the dimensions of these chips dramatically, the demand for smaller, more efficient semiconductors is still strong. So equipment manufacturers have been testing new production methods and 3D design techniques, including a process called extreme ultraviolet lithography.

In general, we expect smaller, more power-efficient chips to become ubiquitous as they run more applications, function as sensors in the so-called Internet of Things and enable technological wonders such as autonomous vehicles. Companies that make the equipment used to manufacture these chips also offer some attractive investment opportunities. Although the semiconductor industry is usually considered a cyclical industry, we see a strong secular tailwind benefitting semiconductor companies and related capital equipment manufacturers.

We are also seeing interesting advancements in software, especially in cloud computing. For instance, software vendors are offering software-as-a-service (SaaS) on a subscription basis, which allows customers to access (and even to develop) applications without the need to buy and maintain hardware. Likewise, networking is increasingly being driven by software rather than hardware.

Our focus is primarily on long-term secular growth themes in the tech industry. That includes large, well-established companies and smaller companies that are innovative and agile. 


Source: Strategas Research Group/FactSet.

This communication is intended solely to provide general information. The information and opinions stated are as of December 27, 2016, and may change without notice. The information and opinions do not represent a complete analysis of every material fact. Statements of fact have been obtained from sources deemed reliable, but no representation is made as to their completeness or accuracy. The opinions expressed are not intended as individual investment, tax or estate planning advice or as a recommendation of any particular security, strategy or investment product. Please consult your personal advisor to determine whether this information may be appropriate for you. This information is provided solely for insight into our general management philosophy and process. Historical performance does not guarantee future results and results may differ over future time periods.


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