Countless thousands of words have been written over the last six days about the investment implications of the new American President, and your author has read much of it. The consensus seems to be it’s all over for bond proxies like REITs, infrastructure stocks, utilities and Telstra now the Trump reflationary trade is pushing bond yields higher and reducing the appeal of these stocks. The prospect of the world’s two largest economies, China and the US, simultaneously injecting infrastructure stimulus is indeed a powerful theme for industrial commodity prices, which have rallied. By design, our model portfolio has been on the right side of this trade with no exposure to the bond proxies.
The market has taken four days to price in four years of Trump. Investors’ verdict is clear and certain: a Goldilocks combination of a little more inflation and a lot more growth, and no nasty surprises like a trade war, a diplomatic/military disaster or explosive negative statements by the new president. There seems to be an assumption Congress will swiftly pass new spending bills and tax cuts after Trump’s inauguration on 20 January.
But beware certainty in the market. It usually represents one extreme reached from the other extreme and is therefore more likely to revert to less certainty than extend further to total confidence. Moves based on hope are particularly vulnerable to any sign they might be wrong and the larger the move, the more vulnerable they become. The 20-month life of this portfolio has been dominated by consensus perceptions of utter uncertainty to the point investors were prepared to accept negative yields on some sovereign bonds and pay huge premiums for the handful of ASX stocks with strong growth, for example Domino’s Pizza Enterprises, and high-quality business models delivering secure distributions, for example Transurban and Sydney Airport. There were five panics over the period: ASX bank equity raisings, China’s growth slowdown, the collapse in oil prices, Brexit and fears Trump was about to win the presidency. Every one of these was an opportunity to build positions in trading and quality investment stocks, and the portfolio took them. At times, like after Brexit when we were most confident, we invested aggressively. This investment style, and more successful stock picks than failures, is why the portfolio has outperformed.
The time to buy is not only when the market thinks the world is about to end but when you do too. The time to sell is not only when the market sees nothing but blue sky but you do as well. If we are heading into a different world of perceived certainty about good or better times, as opposed to the fear and loathing of the last 20 months, then the portfolio is quite prepared for this new world. We’ll keep doing what we’ve done so far: go against the market at its extremes, choose undervalued investment stocks from a focus list, and take a relatively small number of trading positions along the way.
One possible scenario is bond yields get overextended and have a blow-off top. We are already preparing potential switches if this happens, for example a trading rotation back to the bond proxies. One idea would be to buy Westfield Corp (WFD) if US retail sales surge in response to Trump’s middle-class tax cuts and Americans start feeling great again, which would stimulate the national instinct to spend in shopping malls. WFD, which owns 33 malls across the US, would benefit from this. The stock is down ~26% in four months as its premium in a low-yielding world exits the security price.
QBE, our leveraged exposure to higher US bond yields, has rallied to within striking distance of our $11 31/12/16 valuation. The 31/12/17 valuation is $11.31. The stock remains in the trading portfolio, not the long-term investment portfolio, and we intend to exit at the right time and price. Unless a new round of consensus earnings upgrades starts and pushes the stock higher, at this stage we see $11-11.31 as a reasonable range for selling.
So far the New Zealand earthquake does not seem to have material implications for QBE’s earnings guidance. Unlike IAG the company has not announced any exposure to the ASX.
We do not yet have conviction on any rotation from QBE to the bond proxies but the message of today’s column is to:

  • Be sceptical of strong consensus views in the sharemarket
  • Investors who positioned their portfolios to benefit from a trend that happened should consider the circumstances and prices at which they would exit. Intrinsic value is a reasonable input to these decisions
  • Prepare potential switches if successful trades become overextended or too crowded. Today we wanted to demonstrate how investors can think and plan ahead.

Political risk in the age of populism

Brexit, Trump, Australia’s federal election and upcoming European elections mean investors must factor political risk into their decisions. A reasonable base case for how much lasting change Trump will actually deliver in areas which matter to investors (taxation, public spending, private investment in infrastructure, trade, policy towards banks and Wall Street) is 75% inertia, 25% negotiated backdowns from campaign rhetoric. Trump’s base will soon be disappointed by the lack of change relative to its expectations because the emerging presidential and transition team is already dominated by the special interests whose lobbying swamp he vowed to drain. As a populist outsider with no government experience Trump must rely on those who have experience at drafting legislation, negotiating it through Capitol Hill, negotiating executive orders which won’t be annulled by legislators, and dealing with lobbyists and vested interests. These types are conservative because they benefit from leaving government the way it is. Some of the most prominent appointments are standard-bearers of the populist right but below this level, most will be experienced Washington hands.
The fiscally conservative Republican Washington establishment is largely opposed to much of the Trumpist agenda, especially massive public spending and the entitlement programs on which Trump’s base depends. This includes Vice-President Mike Pence, a small-government conservative. Outgoing President Obama proposed multiple public infrastructure spending plans, most of which were rejected by the Republican Congress. The most likely outcome under Trump is spending bills prove harder to pass than expected and there is a negotiated increase in public infrastructure spending which falls short of extreme forecasts. This argues against expecting the current spike in bond yields to extend much further.
Also, Trump’s personal interests are aligned with the coastal elite from which he hails, not the disadvantaged base which elected him. Investors should if nothing else back self-interest here – because at least we know it will be trying given the president-elect’s record of placing his interests above those of other stakeholders like employees and taxpayers. He is a property developer with a large empire of hotel, entertainment and retail properties, which means he will not want a recession, a damaging trade war or a military war which affects US consumer confidence. The US economy was already strengthening before the election. Employment growth is solid and consistent and wages are accelerating. These trends benefit commercial property owners and are the trends to back.
The risk is more what Trump will say to win back his base as it rapidly loses faith when inequality gets even worse as corporate and inheritance taxes, the agenda items which will be easiest to pass, are cut. The new president’s already poor public opinion ratings will come under further pressure from perceived policy biases towards personal interests and 75 pending civil lawsuits against Trump with the first to start in two weeks according to media reports. The next four years will be a struggle between President Trump’s need to bolster his sagging polling numbers, the Republican establishment’s opposition to much of his agenda, and the US Constitution’s checks on executive power. Resulting volatility could provide opportunities to buy quality companies inexpensively.

RCG Corporation (RCG)

The portfolio has benefited from the Trump reflationary trade via its exposure to banks, QBE and CPU. Collins Foods has also rallied nicely. Our only investment this week was RCG, where we took advantage of further weakness to top up to a new model weight of 2.5% by buying 1,937 shares today at $1.40. The stock seems to be pricing in a downgrade at the 25 November AGM and there is also some concern after recent disappointing US sales for shoe brand Skechers, where RCG has the Australian distribution rights. We doubt the company will downgrade its earnings guidance at the AGM but if it does, we have room (and cash) to lift the model weight in a stock we are happy to hold for the long term. If there is no downgrade the stock should rally. The share price is back to levels before the accretive acquisition of Hype.
Originally published on StocksInValue on Tuesday 15th November 2016