It’s a bird! It’s a plane! No, it’s the Dow Jones Industrial Average!
And Donald Trump!
2016 is ending with those two icons totally dominating financial media. Why wouldn’t they? Wall Street loves hope, and Trump’s bringing a whole lot of it with potential reforms. That works for the Dow, and the timing is quite good…the year-end season is adding to the good spirit, and with the post-election rally, the closeness to 20k is providing a solid round number that everyone can discuss over holiday dinners.
Most projections for major political events were totally off this year – note Brexit and the US election – and so were the worries that a Trump win would catalyze a Wall Street apocalypse. Since November 9th, the major indexes are up over 5%, with the Dow up nearly 9%. The general optimism goes way beyond the Hudson and East Rivers; consumer confidence indexes, manufacturing surveys, employment numbers and so much other data indicate America is in pretty strong shape.
But wait, it’s not like we woke up last month – and were like viola – it’s a strong economy! The progression’s been happening over several months. So, is the (massive) post-election rally providing incremental gains based on Trump’s new cabinet and reform ideas? Or have investors simply pulled gains from 2017 into 2016?
To attempt to answer this, let’s first look back into 2016. Wall Street consensus estimates were looking for mid-to-high single digit gains (similar to pretty much every other year) for the market. This time, they were quite right – the S&P 500 is returning nearly 10.5% YTD.
I, personally, wasn’t as optimistic. Earnings would grow and inflation would rise, but I felt a P/E multiple contraction would lead to muted gains, if any, for investors due to tighter financial conditions as the year went on. That didn’t happen. We started 2016 at around 14x forward earnings; today, we’re sitting at 17x (FactSet data). Is it warranted? Some of it, maybe: through the year, oil has stabilized, domestic wages started growing quicker, and earnings growth went back to positive in Q3; a much-hyped rate hike didn’t scare off investors either, indicating confidence in the economy. On top of that, equities have absolutely been the place to invest if you wanted some yield; the S&P 500’s 2% dividend yield was higher than that of the 10-year Treasury for a majority of the year.
Ok, so those are some facts that favored market gains. Now, on to the gloomier side – the role that speculation (at least, that’s what I call it) played in the expansion. If you blinked, you might have missed it – since Nov 8th, the banking sector has been resurrected, literally from the ashes; Goldman Sachs and others are up over 30% in a single month…much of it based on potential deregulation once Trump comes in office.
30%? In a month? For a Dow component, based on possible policy changes? Ok…enter, uneasiness. Small caps, meanwhile, are up over 20% in the same span; a big part of it has to do with corporate tax reforms, which could add between 5% to 25% to their earnings, per estimates. To find the exact figure, we might need about…another year. Again, possible policy changes – but why wait and see if you can buy now? That’s how the market is thinking, at least.
Moving along…infrastructure spending could spur construction and engineering firms. Roads? Airports? Rail? Time horizons? Unclear. A worst case scenario could use the example of Boston’s Big Dig – delivered 8 years behind schedule and nearly 4x over budget. So, expenditures that will happen over many years – with unsure returns. A 9% Dow rally in a month – to 14% YTD – strikes me as a bit premature. And if that’s not enough, nearly 40% of S&P 500 revenues originate overseas. If trade agreements are renegotiated, ripped up or kept, who gets hurt? Who wins? We don’t know! It’s too early!
My bottomline: It’s great to be optimistic – I definitely am, and also with this new administration. But I believe the optimism is heavily based on speculation – and that’s not good. It’s why this recent run up has me worried about next year. Were things so bad up until November that investors just needed some out – including a political outsider who would definitely bring change, but with no market expert having the credentials to predict to what extent? And once the results came in, why did investors pile in to equities as if there was no later train leaving the station? Let’s not fool ourselves – the past decade’s bull market has hardly been a euphoric one, but it has returned nearly 280% since the ’09 bottom. Greed isn’t ever good for your returns. Stocks are expensive, and I still believe the P/E contraction is overdue; therefore, 2017, to me, holds very little hope for the broad indexes to begin with. I say ‘to begin with’, because we’re looking at a total wild card – a sort of binary approach where there may be major policy revamps, or just minor ones – and that clarity will only come as Trump settles in to the White House. 2017’s market will be heavily fiscal-policy and regulatory-driven. Of course, amid the waves up and down as investors trade on Washington news, the smart ones can definitely look for bargains, because there might just be a whole lot of babies being thrown out with the bathwater on Wall Street next year.
Anyway, enough year-on-year talk. In the long run, this will all be noise. Let’s talk multi-year trends – ones that have proven over history to lead to both progress for the world and prosperity for investors.
For 2016, the key themes were highlighted in the year’s outlook; demographic behaviors (environmental awareness, social impact, valuing time, etc.), the rise of artificial intelligence and fintech, an emphasis on autonomous driving, and a drive towards automation all panned out as expected; each has provided 20%+ growth markets in numerous subsectors, including robotics, sensors, and machine learning, etc. Other ideas yet to enter mainstream markets include blockchain-driven platforms, alternative energies (for example, hydrogen power), and chatbots (atleast, not yet in the US).
For the trends above, numerous stocks uniquely indicated them with outperformances – including iRobot (IRBT), Teradyne (TER), Facebook (FB) and Amazon (AMZN). A key tell, however, was Nvidia (NVDA), up a whopping 205% in ’16 after 60% in ’15. Here’s a company that has positioned itself for multiple major trends that Wall Street likes – including VR, autonomous driving, and artificial intelligence. Investors rewarded it well, and even after its massive run, Fortune is highlighting it as a top stock for 2017.
Key stock disappointments included Twitter (TWTR), Under Armour (UA), Nike (NKE), and Starbucks (SBUX). All have unique, differentiated products in growing markets with high brand equity. Consider Twitter. Twitter handles accompany names wherever they are displayed, be it on television or on billboards; it’s also the preferred mode of communication for the incoming president, as well as real time journalism and media. Under Armour and Nike pulled back from expensive valuations; Starbucks had slowing same-store sales growth and macro worries. Patience is a virtue here; each of these companies should be able to bounce back in the long run after temporary rough patches. We’ll talk more on these and others in the coming posts.
And then, for 2017, some final thoughts on trends to watch for:
Look for science to lead the way: I believe that in 2017, VCs, growth investors and the media will focus less on revenues and profits (yes, this may sound ridiculous), and more on breakthrough technologies which may be several years out from, if even, delivering a product. What am I talking about? Firms focused on curing cancer, backed with strong science. Firms revolutionizing transportation, such as Hyperloop One, which is talking with governments for trial tracks as early as next year. VR and AR firms such as Magic Leap, which, per Forbes, could entirely disrupt the $1 trillion consumer electronics industry by beaming a screen right on our retinas instead of mounting the television on your wall. Or ultra-fast air travel via firms such as Boom Supersonic, which is aiming to reduce travel time by 60% across continents. The bottomline? Firms which are focusing on far-flung frontiers will attract smart minds given today’s generational mentality of making an impact. Wall Street’s attention will follow.
Look for people to understand their health better. We all love food, but which food suits us better than other foods? Probiotics and liquid nutrition might gain prominence. And, with augmented reality and smart appliances, the availability of continuous streams of vital data – say, heart rates, oxygen levels and blood pressure – will help provide direction to healthcare workers and ourselves on staying healthy.
Look for geopolitically insensitive companies to prosper. Social media has no boundaries; nor does the concept of sharing, being ‘live’, or utilizing idle assets. Companies that can satisfy certain social and daily tasks that don’t change across countries – say, buying food, commuting, or communicating, for example, will continue to get highlighted as the value of time and quality of life takes priority. Alongside, artificial intelligence will keep ramping up. Alphabet (GOOG) bought Deepmind in 2014, per The Economist, to keep researchers away from competitors. IBM (IBM) bought The Weather Channel. And the CEO of Palantir, a $20 billion big data analysis firm that barely anyone outside the industry knows about, was part of the tech summit with Donald Trump this month. There’s no stopping these trends. More data, more intelligence, and a better life for all is the objective, and it’ll keep gathering pace.
What it means for you: 2017’s going to be a strange year. Washington will probably dominate all headlines. Policy changes will keep investors on edge, and make them run for the exits and entrances en masse. And we’re coming off of a long, long, bull market into a tighter rate environment, a stronger dollar, higher inflation and an elevated risk of overseas turmoil (think emerging market debt concerns, currency issues, etc.). Consensus estimates from Wall Street are looking for approximately 5% in returns. Things might change drastically, though, based on the new administration’s behavior; Q1 will be a great indicator. Keep the vision, keep the faith, and know that companies that have a meaningful mission and great products will always prevail in the long run. We’ll highlight these as the year begins. Wall Street is well known to reward the brave, and investors should remember that in 2017.
