In the lead up to Brexit Robert Swift, head of the TAMIM Global Equity High Conviction Individually Managed Account (IMA), took the view that one could effectively immunise a portfolio from the effects of potentially massive global economic events like Brexit or the upcoming US Election. Having successfully taken precautions to hold stocks that rode out Brexit admirably he now turns his attention to the US in an attempt to immunise the global equity portfolio against any shocks following the US election. The themes presented here should present strong investment opportunities whatever the outcome of the election may be. Robert also provides us with a list of stocks he is watching with this in mind.
In the lead up to Brexit Robert Swift, head of the TAMIM Global Equity High Conviction Individually Managed Account (IMA), took the view that one could effectively immunise a portfolio from the effects of potentially massive global economic events like Brexit or the upcoming US Election. Having successfully taken precautions to hold stocks that rode out Brexit admirably he now turns his attention to the US in an attempt to immunise the global equity portfolio against any shocks following the US election. The themes presented here should present strong investment opportunities whatever the outcome of the election may be.
Trump vs Hillary - Immunising the Portfolio
Robert Swift – Head of Global Equity
On November 8th America votes for the next President. The USA electoral system is not the same as in Australia. If you want to understand more fully how it works please check this out.
We don’t know who is going to win. It looks a close race. Typically voters who prefer the ‘unpopular’ or ‘unfashionable’ candidate will tend to be reticent about volunteering that information.
The vote for Brexit was a recent case in point. Voting ‘out’ was so unfashionable that respondents lied about their intentions causing the polls to falsely predict a ‘Remain’ victory. Consequently Donald Trump is probably closer to Hillary than the media that we watch and read, would suggest. At a recent conference we attended, a USA based Professor of Economic History suggested that Donald Trump could get 60% of the popular vote - not 60% of the electoral college but 60% of the turnout.
It could easily be irrelevant who wins. The President can’t always get much done if Congress isn’t ‘on side’ and either candidate could find they don’t get the support of the two houses in Congress – the Senate and the Representatives. Conceivably Clinton and Trump could each find themselves stymied by an obstructionist Congress and there will be no major economic or foreign policy shift.
As investors watching this event unfold we have some choices to make if we think that market will react differently. These can broadly be classified as:
1 and 2 are risky in that we might be wrong. We think that Hillary will stand for “more of the same” for USA foreign policy but will ‘punish’ big Pharmaceuticals and (sort of) punish Wall St.
Avoid pharmaceutical companies and maybe be wary of companies that play egregiously unfair games with their tax rates – they look unpopular everywhere?
We don’t really know what Donald would do but it will probably involve much posturing about radical change and would result in quite a volatile ride for global capital markets.
Companies with large cash balances may bring money back to the USA if there is a tax amnesty. We should favour Google, Apple which might have a harder time under Hillary?
If we decide we know nothing we could hold cash. Occasionally that has been a good decision.
If we opt for 1, 2, or 3 and pick stocks we think will benefit, or hold lots of cash, but are wrong, it would be an unnecessary and sub optimal decision. We have thought about it and have decided we can do in USA stock selection what we did with UK stocks before Brexit. Namely we can invest in US stocks that we think are attractive which will be immune from the downside of a win by either side. Before the Brexit vote we decided that large multi-national companies which happened to be listed on the UK Stock exchange were cheap. Glaxo Smithkline, the pharmaceutical company, and HSBC the UK and Chinese bank, were likely to benefit regardless of who won the UK referendum. Both had global products, a global presence, good products, good balance sheets, attractive valuations and a compelling catalyst.
Glaxo and HSBC are both up over 15% since the June 23rd Brexit vote.
Here's how we think we can do the same again in the USA. We believe 3 trends will continue regardless of outcomes 1, or 2, above. If we can pick the right stocks our investors should do ok and certainly better than by holding cash yielding virtually nothing.1 - The USA yield curve will start to steepenThis means that longer term interest rates will rise relative to shorter term rates. Note we are not claiming that short term rates will be raised (although we wish they would). This steepening typically happens when an economic recovery is being discounted and investors expect more demand for, and a higher cost of, longer term money.
This steepening invariably helps lending banks since they tend to borrow short and lend long where the lending rate resets upwards quite frequently. In short it boosts bank margins on their loan book. Many USA banks are cheap relative to their expected muted but stable, dividend and profit growth. They are also ‘safe’ to the extent that they have raised over $700b of common equity since the first stress tests in 2009. USA banks are a lot safer than they were before the 2008 GFC and while they are a lot less ‘exciting’ now, we think it’s ok to invest in utility type companies which have a tailwind of higher margins. Additionally, the European banks are not well capitalised; the European yield curve is unlikely to steepen; European stress tests by the ECB are a fantasy which gives investors no comfort about their veracity; and they are exiting businesses, leaving it to the Americans.
We could be wrong. Wells Fargo is under fire for unethical business practices but any fine is unlikely to mortally wound the company. European banks are trading on ostensibly much cheaper ratios and so they could outperform if the landscape changes. Given the intransigence of the German government in refusing to use taxpayers money to bail out Deutsche Bank, or the Italian banks, we think “muddle through and uncertainty” prevails in Europe. If Deutsche had to pay the proposed fine of $14bn then it would be a mortal blow – at least to existing shareholders. 2 - Infrastructure spending in the USA has to go upWe have been saying this for a while – especially when I lived there! The decrepit state of the roads, railways, bridges, and schools has to be seen to be believed. It is 60 years since the Eisenhower administration built the national highway system and over 25 years since there was a new international airport opened - Denver. Infrastructure spending is running today at about half the average level of the last 100 years, as a % of GDP. 2.6% vs 5%. This is equivalent to a lot of new $ to be invested. If Trump wins maybe contracts go to USA companies only? If Hillary wins, maybe it goes out to global tender? There is the money and the knowhow! If you have been to a sports stadium in the USA you will see evidence of civic pride and evidence of the will to find the money. We have been to college bowls which hold 80,000 spectators. We think that pride and skill will now be turned to general infrastructure and both candidates are talking about it – a lot. Hillary has promised $275bn of federal spending over 5 years and $500bn in total and Donald twice that, provided by a national infrastructure fund. Hillary’s proposals seem a little more soundly costed but Australians will know all about the debate surrounding that issue!
Check out this website (www.infrastructureusa.org) to get a sense of news and views on North American infrastructure and the political stance of both opponents on the issue.
Which stocks benefit? Construction companies, manufacturers of heavy trucks, Steel companies, Concrete companies, Technology companies and Capital goods stocks. Pretty much everyone and even those pariahs, the banks. It makes so much economic sense and, thankfully, if enacted will allow the era of Zero interest rates to come to an end since the economy will get a boost.
We are invested in Daimler for heavy trucks, Vinci for construction skills and Honeywell for capital goods. We also expect technology stocks to benefit since much of the infrastructure will be wired up.3 - New inventions and innovation, especially in Technology, continuesTechnology is already everywhere and in everything but we can’t see that trend stopping. Mobile phones today contain more computing power than did Apollo 11 for its moon landing.
Neither Hillary nor Donald is going to do anything to prevent the USA develop further. Arguably it will even be given a boost by the new President because Chinese patent applications are now running ahead of those in the USA. It has a geopolitical dimension.
In the digital economy we think there are 3 certainties:-
Pretty much everything we own has technology in it and increasing amounts of it. Glaxo SmithKline is now working with Alphabet (Google) to develop bioelectronic medicine. Toray was a manufacturer of seatbelts for Japanese cars but is now also a global leader in membrane technology and designing carbon fibre shells for aircraft. Western Union from the USA uses sophisticated software to transmit electronic payments of over $150bn via 500,000 agent locations in 200+ countries. Anyone remember travellers’ checks?
If we can invest in companies that develop or implement, technology at a good price then we are happy. We don’t invest in start-ups, nor in smaller companies with single products but find plenty of opportunity globally but especially in the USA. We don’t see that changing post November 8th.Stocks on these themes:Below are some stocks which are attractive on our ‘multi factor’ stock selection model. This ranks stocks based on their relative attributes with regards to Valuation, Quality of earnings and balance sheet, and earnings and price Momentum. We call it VMQ. Typically stocks with higher scores outperform those with lower scores but we only invest after verification by performing fundamental analysis on a company’s future prospects, paying careful attention to accounting, strategic and governance shortcomings. Note that we don’t own many of these because our strategy has to be responsible. We don’t put all the eggs in one basket and so select from amongst a range of industries and regions to get the best stocks which, together, provide diversification and a good risk adjusted return.US yield curve steepening - USA listed financial stocks we like:AFLAC (AFL.NYSE) - VMQ Score = 98
A provider of supplemental insurance against income and asset loss with medical especially popular. Dominant in USA and Japan.
JP Morgan (JPM.NYSE) - VMQ Score = 86.6
A global multi segment bank with investment banking, asset management and consumer banking. It has been through many stress tests and raised a lot of capital. Well placed to benefit from the withdrawal of European banks from the global scene.
Bank of Montreal (BMO.TSE) - VMQ Score = 95
More of a retail bank than JP Morgan this is strong in Canada and the USA mid-West. The build out in asset management and infrastructure financing is attractive.
Principal Financial Group of Iowa (PFG.NYSE) - VMQ Score = 99
An asset management and insurance company with a focus on retirement products.
BB&T Corp (BBT.NYSE) - VMQ Score = 81.7
A retail bank offering personal loans and mortgages. The stabilisation of house prices and the need to replace aging cars will be a driver of interest margins and loan growth.Infrastructure Spend - Infrastructure, Materials, and Capital Goods stocks we like:Vinci (DG.EPA) - VMQ Score = 85.8
A French listed but global construction company with significant exposure to stable revenue from operating infrastructure such as airports and toll roads.
Eaton Corp (ETN.NYSE) - VMQ Score = 79
A power management company – electrical, hydraulic, mechanical. All aspects of major construction and capital goods investment and replacement covered.
Parker Hannifin (PH.NYSE) - VMQ Score = 68
A manufacturer of components to regulate air, water, and motion. Will be a late cycle beneficiary but share price likely to discount before news flow gets better.
Dow Chemical (DOW.NYSE) - VMQ Score = 93.5
Supplies the raw materials that go into pretty much everything that is made globally.
Cummins (CMI.NYSE) - VMQ Score = 93
Makes diesel engines for trucks and power generators.
Siemens (SIE.ETR) - VMQ Score = 89
A German based but global conglomerate operating in power, transport, healthcare and factory equipment. Evidence it is becoming more focussed should help profits and rating.Technology and Innovation stocks we like:Apple (AAPL.NASDAQ) - VMQ Score = 90.6
A very large cash pile which needs to be deployed makes this hard to gauge but net of cash it is trading cheaply as a dominant mobile phone designer.
Intel (INTC.NASDAQ) - VMQ Score = 95.6
Moving from relying on microprocessors to a general provider of hardware and software platforms for the digital age.
NetApp (NTAP.NASDAQ) - VMQ Score = 92.7
Software to manage customer data.
Cisco (CSCO.NASDAQ) - VMQ Score = 97
Switching and routing gear for the internet and moving into software.
Xerox (XRX.NYSE) - VMQ Score = 91.5
Imaging and business process and printing services. An iconic name which will come under increasing shareholder activist pressure without an improvement in results.
Consequently we won’t be holding a lot of cash ahead of this election. We will continue to invest in mis-priced companies with identifiable competitive advantages and a solid strategic position. If we are right about these 3 trends we expect to come through November as safely and profitably as we navigated Brexit.
The team at TAMIM
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TAMIM Asset Management provides general information to help you understand our investment approach. Any financial information we provide is not advice, has not considered your personal circumstances and may not be suitable for you.