While the United States surprised many with its choice of President, once all the uncertainty has been resolved, we expect the result will eventually be positive. Based on the key issues on which now President-elect Trump campaigned, we would expect to see: 1) tax reform, particularly reducing the corporate tax rate; 2) fiscal stimulus, with a key focus on investing in infrastructure; 3) oil markets continue to recover, given President-elect Trump’s favourable view of fossil fuels; 4) healthcare providers to be impacted by the repeal of the Affordable Care Act (ObamaCare); 5) the banking sector to find some relief, given President-elect Trump is strongly against new regulations within financial services. In this report we explain why rates go higher, and two insurance stocks that stand to benefit. We also look at healthcare, oil and infrastructure, and why a focus on value is more important than ever. (VIEW LINK)
Rising bond yields
US bonds sold-off following confirmation that Donald Trump would become President of the United States, with the US 10-year bond yield rising 0.2% in the first trading session.
The main market sensitivities surrounding the Republican’s policy platform relate to inflation and growth, with the market seeing the party’s general anti-trade, anti-globalisation and protectionist policy stance as inflationary.
In a bond pricing framework with little or no inflation premium, or any meaningful term premium, this has been the catalyst for bond yields to jump above 2.0%, their highest level since January 2016.
Our Australian equities portfolio has a substantial underweight to bond-sensitive stocks, like REITs and utilities, which we believe have looked extremely expensive for some time.
A steepening yield curve, however, is considered positive for banks globally.
While Australian banks are less sensitive to this theme, any increase in bond yields is positive for bank earnings, especially in an environment where top line earnings growth is difficult to generate.
We are overweight banks within our Australian equities portfolios, driven by our strong belief that the market has been overly discounting future capital issues and increasing bad debts.
The combination of a banking sector that is trading close to a 25-year low versus industrials, with around a 6% dividend yield, means the banks in our view continue to look attractive.
Rising bond yields are likely to reduce the flow of competing capital into the general insurance sector from financial investors, while investment returns on the premium float held by insurers should also rise. We hold both IAG and QBE Insurance within our Australian equities portfolios. QBE is well-positioned to take advantage of this environment, due to the company’s unique asset liability mismatch.
New infrastructure spending
We would expect companies with US exposure within our Australian equities portfolios, like Boral, BlueScope Steel and Incitec Pivot, to benefit from President-elect Trump’s policies of reducing corporate tax and increasing infrastructure spending.
While a US$305bn highway spending bill was announced in December 2015, there is now the potential for this to be much larger and more diverse than just highways and transit projects.
We would expect BlueScope Steel to benefit from strengthened steel import tariffs, through potentially higher domestic steel prices via its fully-owned North Star business, an Electric Arc Furnace steel manufacturer strategically located in the US mid-west.
Incitec Pivot’s position as a leading explosives supplier to the US quarry and construction sectors, via its network of JVs, should also be positive for earnings in the medium term.
What about oil?
While oil markets have recovered their initial losses following the election, there are multiple factors surrounding oil that we must now consider.
With the OPEC meeting in three weeks, President-elect Trump’s policies to encourage domestic oil development could add to OPEC’s concerns around potentially losing market share.
We would argue, however, that the greater impediment to US hydrocarbon development is price – without a recovery in oil, US Government policy alone is unlikely to drive a rise in activity.
Another key issue is the shifting US foreign policy towards two key oil producers, Russia and Iran, and the sanctions that were previously put in place and then recently lifted.
We remain positive about oil markets, as we expect OPEC to come up with a supply response to support member revenues.
There are certainly risks to this view; however our holdings in Oil Search and Woodside should help to manage these risks, given the low cost resources, strong balance sheets and quality management teams of both these companies.
Major changes to health care
Although President-elect Trump has indicated he intends to repeal the Affordable Care Act (Obama Care), he has also suggested that this would be replaced with “something else”.
There is no detail on what this “something else” is, although President-elect Trump is thought to be supportive of Health Savings Accounts and some form of healthcare program for the very poor.
You would expect repealing this legislation, in isolation, to be negative for healthcare volumes. However, with healthcare providers not reporting a spike in volume or utilisation following the introduction of ObamaCare, this policy reversal may actually have little impact.
We remain significantly underweight healthcare within our Australian equities portfolios, primarily due to the lack of value opportunities, with our main holdings in Ansell and Resmed.
Given its broad industry exposures via its industrial glove business, Ansell should benefit from any recovery in economic activity that results from more expansionary fiscal policy.
A focus on value…
We have been commenting for some time about what we see as the enormous valuation differential between value stocks and other low volatility, bond-sensitive and growth stocks.
The 20+ year bond bull market looks to have peaked and we have recently seen bond yields bottoming out.
Although catalysts for major changes are always difficult to discern ahead of time, we have pointed to a combination of fiscal policy intervention and a cessation or reduction in quantitative easing as likely signals.
The surprise election of Donald Trump on a pro-growth platform, and Republican majorities in both the House and Senate, is arguably inflationary and could be the catalyst that bursts the bubble.
Since the announcement, we’ve seen some huge moves in stocks that are leveraged to US growth and rising bond yields.
We believe our carefully-selected portfolio of Australian stocks via our active intrinsic value approach is well-positioned for this market rotation, as well as identifying new investment opportunities that will generate returns for our clients.
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