Other reasons for his dour view include the fact that Trump’s proposed tax cuts, defense and infrastructure spending increases will only add to a “mountain of government debt” approaching 100% of GDP. That’s the tipping point at which experts like Rogoff and Carmen Reinhart believe economic growth starts to get hamstrung, Swanson notes. Stalled productivity gains and an exodus of baby boomers out of the work force and into entitlement programs won’t help, either.
Tax cuts for the affluent are unlikely to trigger much of a spending multiplier effect in Swanson’s view. As for cuts in corporate tax rates, the strong U.S. dollar may offset domestic profit gains for many S&P 500 multinationals. “Lots of companies have special deductions” and lobbyists will fight to preserve them,” Swanson maintains.
As consumer confidence climbed following the election, so did mortgage rates. “That can’t be positive for the psyche of the middle class,” Gundlach told clients. Rural voters who went overwhelmingly for Trump have high expectations that he thinks could make them vulnerable to disappointment.
Winners And Losers
Any change in American presidential administrations has its winners and losers, but the post-election rally favored old economy stocks in particular. The big losers, by most accounts, were the high-tech growth companies, while names from yesterday like U.S. Steel and Caterpillar staged powerful advances.
Growth has outperformed value for much of the bull market. “When growth is slow, money will pour into the few companies that are really growing,” TIAA’s Nick says. If “growth is going to be more widespread,” investors may not want to pay lofty premiums for it. “In terms of cyclical leadership, we’re willing to swim with the current,” Nick adds.
Technology. In his post-election webcast, DoubleLine’s Gundlach told clients to avoid the FANG (Facebook, Amazon, Netflix and Google) stocks in “a big way.” He found it ironic that the industry that “hates Trump the most” turned out to be the most responsible for his election. In his view, Trump could never have won without Twitter.
Technology’s future is closely linked to the S&P 500. Indeed, charts of the S&P almost mirror that of a large-cap, high-tech ETF, and that’s a major reason U.S. equity averages underperformed many others in the so-called lost decade between 2000 and 2010. Many of these companies face headwinds ranging from lofty valuations to the law of large numbers, which makes it difficult for a firm to increase revenue and attract more customers when it is already by far the biggest player in its market. Facebook, for instance, has warned that its growth rate will decelerate.
But many investors think values in Techland are reasonable. “Google trades at 15 times and Facebook trades at 17 times what we think they will earn in 2018,” Puglia of T. Rowe says. While many technology concerns have relatively low tax rates, they are likely to benefit from more robust economic growth.
Dividend-Paying Consumer Staples. During the income-parched environment of the post-crisis era, these companies became favorites of many bond investors who need income. The investment management industry responded by introducing a smorgasbord of low-volatility mutual funds and ETFs.
The upshot was that many companies like PepsiCo, Coca-Cola, Clorox and Kimberly-Clark saw their shares soar. Even though many of these mature businesses struggled to achieve single-digit unit volume growth rates, they started sporting price-to-earnings multiples in the mid-20s, frequently exceeding those of companies with more exciting businesses. “Investors may favor companies with great economic sensitivity and leverage to this higher growth,” Puglia says.
Indeed, consumer staple stocks were among the biggest losers in the wake of Trump’s victory, with some falling as much as 9% or 10%. When investors get excited about equities as they did after the election, many flock to high-beta names. “A little volatility will [cause] investors to return to high-quality, low-volatility stocks,” says Northern Trust’s McDonald. “It’s too early now.”
Financials. After a decade when it often seemed financial companies could do nothing right, a confluence of factors is conspiring in their favor. “It’s not just deregulation—they’ve underperformed for so long,” Nick says.
Banks typically perform well late in the business cycle and it’s certainly not early. “They were disfavored and hamstrung by [Dodd-Frank] and now the yield curve is in their favor,” says Swanson.
Parnassus Funds founder Jerry Dodson has invested in banking’s bad boy du jour, Wells Fargo, because he likes its high percentage of recurring revenue. Despite its problems with fake accounts, its shares rebounded quickly after the election.
Industrials. This sector is perceived as a primary beneficiary of a potential boom in infrastructure. But the reality is U.S. manufacturers are already doing quite well—they are just doing it with fewer workers.
In the days after the election, Trump’s chief strategist Steve Bannon spoke about building giant shipyards and ironworks complexes, an idea that struck many as anachronistic. “We won’t be investing in shipyards and ironworks,” says Jerry Dodson, adding these investments nearly brought down the Japanese and South Korean economies in the 1970s and 1980s.
A pioneer in ESG (environmental, social and governance) investing, Dodson is open to playing the sector selectively. Several of his funds own Praxair, a manufacturer of specialized industrial gases.
Patel of Wells Capital believes that in the early stages of the post-election rally, a lot of money managers moved from technology into industrials. She worries some industrial stocks have climbed too far, too fast, though she still likes defense stocks.
“All the money that wanted to be in cyclicals was in tech and a lot went into industrials,” Patel says. “Some industrials could be overvalued.” Indeed, Caterpillar has warned investors that 2017 could be its fourth year in a row of lower revenue for the first time in its history and the market ignored its warning as the stock, a Dow component, was a standout in 2016.
Pharmaceuticals. Drug pricing was a favorite target of Democratic nominee Hillary Clinton, and their stocks jumped in the weeks after the election. But then President-elect Trump fired his own salvo at them in early December and many drug and biotech concerns gave back some of their gains.
Pricing and politics are only two of the problems facing this defensive sector. Many biotech companies have enjoyed outsized returns over the last five years as the industry saw a wave of new chemical compounds receive FDA approvals.
But as they’ve come to market, more than a few have posted disappointing sales results. If economic growth accelerates in the next year, investors may seek out less defensive ways to play the cycle.
Potential Dark Clouds
This analysis assumes that the economy and equity market don’t suffer a serious setback. The president-elect stunned both parties and the entire political establishment, but he has no government experience and will learn on the job. Ditto for several of his top advisors.
As Swanson sees it, the odds of “disappointment risk” are high. “What if the new administration makes a major mistake?” he asks. “You don’t have a conservative president.”
Trump may be pro-business but his behavior is erratic and he appears addicted to tweeting out barbs—many singling out business leaders and individual companies—on a daily basis. Given his stance on trade, Swanson thinks the odds of an international dispute could become elevated.
In contrast to Rogoff, Swanson also thinks the economy may be weaker and may be later in the cycle than conventional wisdom holds. “It’s not a recession but you are fighting a declining cycle,” he says.
McDonald isn’t as worried that the new administration could become embroiled in a damaging trade war. But he does think it’s possible the Federal Reserve could tighten more than markets expect.
Concerns about growing budget deficits over the next five years are on point, McDonald thinks. They are currently running at $600 billion a year, and an economic slowdown could exacerbate them.
Gundlach has warned repeatedly about the 10-year anniversary of the Great Recession in 2018. That’s when the big bulge of baby boomers start turning 65 and going on Medicare. This will happen at exactly the same time that 10-year debt, issued when the government was running trillion-dollar deficits, will need to be refinanced.
But for now, the markets are euphoric and the economy, in the midst of the third longest expansion in history, is humming. If there is no recession before 2020, Donald Trump could be able to run for re-election on the longest recovery on record.