U.S. stocks indices have rocketed to record highs since Donald Trump’s presidential win. Damian Fernandes, Portfolio Manager, TD Asset Management, explains how “Trump-phoria” can impact the U.S. dollar, future corporate earnings and various market sectors.
00:00:04.037 Hello and welcome to Money Talk.
00:00:05.472 I am Kim Parlee.
00:00:06.273 Let's begin with a look at the markets and, day after day,
00:00:10.477 record after record, the DOW has blown past 19,000
00:00:14.948 for the first time ever, but that's not the only stock
00:00:17.084 index making records.
00:00:18.352 Take a look at the S&P 500, the Nasdaq,
00:00:20.821 Russell 2000, they've all surged to record highs.
00:00:25.025 This tremendous rally, in the words of Donald Trump, started
00:00:28.028 since the now president-elect Trump won the election on
00:00:30.664 November 8th.
00:00:31.498 So, the question is, after consecutive quarters of
00:00:34.201 declining earnings growth, are companies finding growth
00:00:37.471 Joining me is Damian Fernandes,
00:00:38.839 portfolio manager for the TD Balanced Growth Fund,
00:00:41.742 joining me here in the studio.
00:00:43.877 Nice to see you.
00:00:44.645 Thanks Kim.
00:00:46.046 I like how we've divided up our talk because I think we want
00:00:48.682 to kind of do pre-Trump and post-Trump.
00:00:51.585 Yeah. I think that's the best way to do it because what I think
00:00:54.354 that, and again when I heard you speak a few days ago, is
00:00:57.624 That, even before president-elect Trump was elected, we
00:01:02.462 were seeing some pretty interesting things happening
00:01:04.865 on the earnings side of things.
00:01:06.600 So for us, if you just think about what earnings, were Q3 earnings.
00:01:10.804 So they ended at the end of September.
00:01:12.839 A few companies were reported in October, but generally, the
00:01:15.542 positive momentum you've seen in earnings happened before
00:01:18.812 Trump was even elected.
00:01:20.280 And what we really saw was that, for the first time since
00:01:22.983 Q1 2015, so 5 quarters ago, we've had declining earnings
00:01:28.555 But this quarter, it’s like hooray,
00:01:30.757 earnings are finally positive on a year on year basis and they
00:01:33.860 are positive for factors, reasons independent of Trump.
00:01:37.431 I want to bring the chart up and we can keep talking about
00:01:39.032 this because, as Damian mentioned, it’s been a long
00:01:41.468 Decline, but we've seen contraction in earnings in the
00:01:47.574 past few quarters, as we can see here on the chart.
00:01:50.143 And so, not only have we reversed the trend here,
00:01:52.312 but we've actually, we’re back in the growth territory. Exactly.
00:01:54.915 So why?
00:01:55.916 You were saying there is a number of reasons.
00:01:57.184 Well let's think about the reasons why earnings, first of
00:01:59.219 all, went to the negative territory.
00:02:00.787 There is really 3 main factors,
00:02:02.155 3 co-conspirators, as I like to think about it,
00:02:04.558 one of them being oil. Crude oil went from $102 down to sub
00:02:10.397 We've had a strengthening of the U.S. dollar, and then you've seen
00:02:13.066 emerging markets, whether it's China,
00:02:14.935 Brazil, actually go into, start seeing material slowdowns
00:02:19.039 in their growth.
00:02:19.773 These are countries that companies in the S&P have big
00:02:24.044 businesses in.
00:02:24.811 So, all of those factors contributed for a year and a
00:02:28.048 Half, basically, of an earnings drag.
00:02:30.550 But what's happening now?
00:02:31.918 Emerging markets are no longer in the hospice,
00:02:34.788 they are no longer in critical care.
00:02:36.523 They are actually in the recovery unit.
00:02:38.525 The U.S. dollar is, while it’s just rallied more recently, on
00:02:42.429 a year on year basis, is actually flat versus most of
00:02:45.365 its trading partners. And importantly, oil has finally
00:02:48.168 found a floor.
00:02:49.036 And so, while oil has found a floor,
00:02:51.038 these oil companies have cut costs, so they are no longer
00:02:53.673 a drag on earnings.
00:02:54.875 So all these things are actually helping the S&P,
00:02:57.677 the actual index level. The earnings from the index level
00:03:00.714 start moving up, and we think this can continue.
00:03:02.883 Let me ask you, there is a picture of oil right there at
00:03:05.519 $48 right now, but I want to talk about the U.S. dollar a bit.
00:03:09.089 I mean, if the Fed raises, which I think,
00:03:11.458 you know, the latest is there’s a 100% probability that
00:03:13.627 markets are pricing in right now,
00:03:14.761 I don't think I've ever seen that,
00:03:15.796 except for right before when something happens.
00:03:16.963 But what happens with a stronger U.S. dollar?
00:03:20.634 Because it’s obviously good news for some companies,
00:03:22.369 it’s bad news for others.
00:03:23.537 I think a strong U.S. dollar will be a headwind for a lot
00:03:26.239 of multinational companies, but you have to recall that
00:03:28.075 the current strength we’re seeing in the U.S. dollar is
00:03:30.811 already pricing in a Fed rate hike in December.
00:03:34.114 What matters for the U.S. dollar to continue rising is that if
00:03:38.552 there is, if the Fed raises rates a lot faster than the
00:03:41.955 market expects.
00:03:42.889 Right now, there is two rate hikes priced for 2017.
00:03:45.625 If the Fed starts raising it a lot more, then you can see the
00:03:50.030 U.S. dollar start strengthening a lot more.
00:03:51.698 Generally, that's a bad thing, but like I said at the start,
00:03:54.267 the U.S. dollar, the DXY, the broad basket of the dollar
00:03:57.838 index, it's at a hundred and two. It was at a hundred last November.
00:04:01.842 So the dollar actually for most of this year until just 3
00:04:05.445 weeks ago was actually weaker against most of its trading
00:04:09.416 That provided a tailwind for U.S. companies that bring their
00:04:12.285 earnings back home.
00:04:13.386 What about the fact, and I’m going to ask if we can bring that
00:04:16.089 chart up again to show the earnings growth and what
00:04:18.325 happened, is part of this also that
00:04:20.193 we're just lapping really bad quarters previously?
00:04:24.531 Well, that's a big part of it, but the other part of it,
00:04:27.400 let's think about what’s happened.
00:04:29.002 So, we’re talking about the energy sector and how,
00:04:31.204 because of the collapse in crude oil prices, the
00:04:33.774 energy sector was a drag on earnings.
00:04:35.642 Let me put that into some numbers.
00:04:36.810 The energy sector at the end of 2015,
00:04:40.147 at the end of 2014, contributed about 12% to S&P earnings.
00:04:44.117 This year, they’re going to contribute 1.
00:04:46.620 Earnings in the energy sector have collapsed,
00:04:49.990 but, despite that, the S&P is showing positive earnings
00:04:54.427 That means the other parts, they are kicking in.
00:04:57.130 So this is what we would expect. When you look back in history, what you find
00:05:00.000 is that, if earnings turn positive, they continue to do
00:05:03.537 so, and the only way they reverse is if you have an
00:05:06.640 Outside, you know, factor that actually challenges them.
00:05:10.777 And right now, that outside factor generally is
00:05:13.513 recessionary conditions, whether it's either domestic
00:05:15.916 in the U.S. or outside-based, and right now, through our looking
00:05:19.753 glass, we don't really see any evidence of, you know, real big
00:05:23.323 recessionary factors out there.
00:05:24.824 So we think this earnings growth will continue.
00:05:27.160 I've been so looking forward to this part of the
00:05:29.095 conversation because he is going to take us through the
00:05:31.631 mechanics of why we are seeing the market move up right now,
00:05:34.134 and in terms of what people are pricing in,
00:05:36.336 I think which is fascinating.
00:05:37.437 So, first, let's just take a look,
00:05:39.806 you've taken a look at what sectors are doing well,
00:05:41.708 what sectors are not doing so well,
00:05:44.244 post-Trump, post-Trump, and I think we've got a chart here
00:05:47.714 we can show you that – financials in the biotechs, and what we
00:05:51.451 are seeing is, here is how they did before Mr. Trump was
00:05:54.754 elected, and brace yourself.
00:05:56.823 Here is what they've done post.
00:06:00.627 Let's take a look at this one.
00:06:02.062 Financials of the S&P 500, post-Trump, 5.1% total return.
00:06:07.534 That's before Trump, year to date,
00:06:09.102 and post-Trump, 11%.
00:06:11.371 That's not bad for, how many?
00:06:13.640 10 days, 10 or 12 trading days.
00:06:16.042 Regional banks, 20%. Biotech, which was negative on the year –
00:06:19.679 Was down 22%.
00:06:21.314 That's because Hillary was supposed to win, and Hillary
00:06:24.451 cared about pricing in the health care sector.
00:06:27.554 Since then, 7.5%.
00:06:29.489 So, sorry, is that the return so far?
00:06:31.358 So it's actually gone up almost 30% on biotech, is that
00:06:34.961 No, its return since the end of –
00:06:38.098 Since the end of...
00:06:40.066 Incredible indeed.
00:06:41.134 Now, the flip is also true for, so the more defensive I’d
00:06:44.838 say we are seeing right now.
00:06:45.639 Let's bring up a chart where we are showing I think
00:06:46.573 utilities, consumer staples and real estate, and again we
00:06:51.044 are going to show you the returns until Mr. Trump was elected,
00:06:54.781 and then what's happened afterwards.
00:06:56.783 Just the inverse.
00:06:57.384 It's the inverse of it.
00:06:58.451 And there is a few things that will stick out.
00:07:00.587 All these 3 sectors are proxies for bond deals, or they
00:07:06.159 are defensive sectors where you have consistency of income
00:07:10.063 and high-yielding sectors. They have underperformed.
00:07:13.066 All the sectors before that, what’s - biotech and financials
00:07:16.903 really shouldn't have anything in common,
00:07:18.605 the thing they do have in common is that they are both
00:07:20.740 heavily regulated and Trump has said less regulation.
00:07:24.778 So, it's almost, like the reaction might be overblown,
00:07:28.848 but directionally it makes sense,
00:07:30.317 if you have a new president who is coming in,
00:07:31.718 who has vowed to, for every rule he does implement he
00:07:34.120 wants to cut two rules, you can see how sectors that are
00:07:37.057 under pressure from regulation would be under more benign
00:07:41.594 conditions now.
00:07:42.595 I think we've got a chart here as well on bonds and what’s
00:07:46.166 happened with bonds, again, post Mr. Trump's election and,
00:07:52.539 again, this kind of, I think, just further illustrates what
00:07:54.975 you were talking about in terms of what's happened to
00:07:56.576 treasuries and the bond market in general. So yes,
00:08:00.847 it's the same thing as those other two tables where you
00:08:03.850 have the returns of the bond universe,
00:08:05.719 whether it’s investment-grade corporates or long bonds from
00:08:08.922 year to day until before the election, and then what's
00:08:11.992 happened post the election.
00:08:13.393 And it's consistent, it's all negative post-election
00:08:15.428 because Trump has, I guess, incentivized animal spirits.
00:08:20.433 He has talked about reflationary conditions and,
00:08:23.870 whether it's the bond market or those defensive sectors are
00:08:27.374 selling off because inflation may be in the pipeline, or
00:08:31.544 because, if he’s going to fund those infrastructure
00:08:33.980 initiatives, it will require issue of new debt.
00:08:37.150 Either way, there is a change or what I will call a sector
00:08:40.387 rotation taking place.
00:08:41.855 That is probably some of the most interesting tables I've
00:08:43.757 seen in years.
00:08:44.657 I mean, you talk about an inflection point,
00:08:45.825 you know, in a few days to see something like that, I think
00:08:48.228 it's incredible.
00:08:48.828 Also interesting, you've put some information together here
00:08:52.165 which I want to walk through, because I think people need to
00:08:54.901 understand why the market is pricing in what they are
00:08:57.137 pricing in. Because, he has talked about loosening regulation
00:08:59.072 to a point, corporate tax cuts,
00:09:01.241 personal tax cuts, all sorts of things.
00:09:03.643 One of the positives though is corporate tax rate cuts, and
00:09:08.048 you brought something where you’re going to show us what you
00:09:10.984 could be thinking about everything. Sure.
00:09:12.152 So we've got here, I think, a chart,
00:09:13.553 we’re going to bring this up and I want you to walk us through
00:09:15.822 We’re going to show S&P 500 earnings before this all
00:09:18.324 happened, at 118.80. Now, take us through the rest. So right now,
00:09:23.696 the U.S. statutory corporate tax rate is 35%. Correct.
00:09:26.099 And I know a lot of people say a lot of companies don't pay
00:09:29.068 that, but a lot of the companies that don't pay that
00:09:30.804 are what we will call companies that own
00:09:32.639 intellectual capital that are in different jurisdictions,
00:09:35.241 in low tax jurisdictions.
00:09:36.242 But a lot of domestic-facing businesses,
00:09:38.344 whether you are talking about Union Pacific,
00:09:40.447 the rails company, whether you are talking about Walmart,
00:09:42.749 whether you are talking about American Express, which earns
00:09:45.985 most of their income within the United States, and pay tax
00:09:50.089 on that, they are still pay high thirties tax rates.
00:09:52.892 So let's assume the tax rate drops,
00:09:55.195 Trump is successful, he lowers the tax rate from 35 to 25 -
00:10:00.467 He is talking about 15, Paul Ryan, which is the House
00:10:03.036 Speaker, is talking about 20. Let’s even be more conservative
00:10:05.205 and assume it’s 25%.
00:10:07.440 Just that move from 35 to 25 percent adds about 10 points to S&P
00:10:12.145 earnings, 10 points to S&P earnings if we just put a
00:10:15.515 market multiple.
00:10:16.416 I was going to tell them to bring that chart back up so we can see that.
00:10:17.951 So that's going to bring back, just again,
00:10:19.686 every - on, you know, aggregated, they’re earning ten dollars more per [Indiscernible].
00:10:24.357 And that is real sustained value.
00:10:26.493 So, it's not a transitory thing,
00:10:28.328 the tax rates will be there to stay, so that is pure equity
00:10:31.231 value you create for companies because you are lowering the
00:10:33.766 tax burden, hence increasing their free cash flow.
00:10:36.836 And then you've got the market multiple on this,
00:10:38.104 of 15.
00:10:39.339 And so that's 151 points right there.
00:10:41.708 So, a lot of the move, I think, the move post-Trump, has been
00:10:46.079 putting the consequence before the cause,
00:10:48.281 because none of this has passed yet,
00:10:50.049 and if this all passes it will be great,
00:10:52.852 but the market move has been really excited about focusing
00:10:55.522 on the great things of his policy,
00:10:57.190 but, if he is successful, there is some justification for the
00:11:01.161 Now, you, again further, we don't show it here, but 150
00:11:04.197 points, or 151 points, was around 7% on the S&P 500 from the
00:11:08.101 time you did this calculation.
00:11:09.802 I mean, it's come up since then -
00:11:12.005 record, actually that's the doubt with the record -
00:11:15.708 but we still can see, I mean basically 4% to 5% in moving
00:11:18.611 up from these levels based on this one plank.
00:11:21.214 This is just one plank and he has a few planks he wants to
00:11:25.151 He has the infrastructure plank.
00:11:26.352 He said he wants to double Hillary.
00:11:28.855 Hillary said 275.
00:11:29.956 If we double that, that's north of 500.
00:11:33.693 Let's just assume its 400, just put some numbers out
00:11:36.329 400 billion in infrastructure.
00:11:38.898 The U.S. economy is 18.6 trillion.
00:11:41.668 That's 2% right there, 2% of incremental growth that wasn't
00:11:45.438 there previously.
00:11:46.539 There is that, and then there is of course the repatriation
00:11:50.143 of earnings that can help, for companies to use,
00:11:53.713 to do that, to use share buybacks, and then I think this is
00:11:56.683 a very understated view, which is that whether it was Trump
00:12:00.587 or Hillary, the presidency is over,
00:12:03.122 we know who the president is, there is no uncertainty now.
00:12:06.292 So businesses that might have deferred capital investment
00:12:09.762 decisions, they will start.
00:12:11.831 Although trade, do you think there will be some trade
00:12:14.133 I think trade, I think people - so the market and the media is
00:12:17.203 fixated on all these great things about the Trump plan.
00:12:19.872 There are bad points that, if implemented, will create a lot –
00:12:23.977 There is a cliff.
00:12:24.611 There is a cliff, it will create a lot of uncertainty
00:12:26.546 that might not be - and one of the things is trade.
00:12:29.415 I am just thinking, you know, if I’m a business and I want to
00:12:30.984 invest, I’m going to be hesitant on where, because of trade.
00:12:34.721 So, that's going to cause things too.
00:12:36.422 Listen, I've only got about 10-15 seconds,
00:12:37.824 give me a few names that you think may benefit from these,
00:12:40.059 the typical company that could benefit from these corporate
00:12:42.895 tax rate cuts.
00:12:43.663 We talked about this, let's think about if Trump is
00:12:45.898 successful, rates have moved up,
00:12:47.700 economic growth is improving, regulation is likely moving
00:12:51.671 lower, banks are in great spot.
00:12:53.473 We own JP Morgan in our portfolios and JP Morgan, even
00:12:56.876 after this, is trading at below market multiple,
00:12:59.412 even after this move.
00:13:00.313 It benefits from loan growth, from higher economic activity,
00:13:03.483 from less regulation and it also benefits in terms of its
00:13:07.086 net interest margin.
00:13:08.154 That moves higher because rates have moved higher.
00:13:10.223 Fantastic conversation.
00:13:12.892 I wish we could keep going but I can't,
00:13:14.360 but you will come back right?
00:13:15.128 I will.
00:13:15.962 Damian Fernandes, portfolio manager with TD Balanced Growth
00:13:17.964 Fund, joining me