Trump’s America: Three ways to play US equities as new President takes charge

Donald Trump’s surprise election as US President has created a number of opportunities in US equity markets, with his mooted and controversial policies likely to have a widespread impact across many areas of the US economy, WisdomTree’s Viktor Nossek has said.
Nossek, director of research at the ETF and ETP sponsor, said Trump’s policies have the potential to reverse last year’s uptrend in broad US equity markets to new highs.
Conversely, he said if investors are sceptical about Trump’s ability to implement his plans, defensive sectors still look attractive, with a combination of solid earnings and dividend growth and low price/earnings expansion in their favour.
“As we start 2017, the unknown for investors is whether Trump will actually enact many of his election promises, or whether they will be watered down (or blocked) as they go through the various stages of being enshrined in US law,” Nossek said.
“That said, it is possible for investors to position their portfolios around the potential outcomes if they have a view on what they expect Trump will be able to achieve.”
Below Nossek has outlined three strategies which investors could pursue this year depending on their expectations for the new US President.
Thumbs up for Trump
For those investors who expect Trump to be able to instigate his range of policies, Nossek said cyclical sectors which lagged peers under the previous administration may offer the best route forward.
“If you believe Donald Trump’s policies are going to succeed and accelerate economic growth then a focus on stocks with low leverage, high profitability and the ability to cash flows in a select number of sectors Trump is looking to reinvigorate now looks attractive,” Nossek said.
“Along with Health Care, the sectors for consideration are Industrials, IT and Consumer Discretionary which, bar from a few companies overwhelmingly reported disappointing earnings last year, could see their earnings growth projections upgraded when corporate tax cuts and infrastructure spending programs become law”
Nossek said one way to play this pro-Trump theme is via the WisdomTree US Quality Dividend Growth ETF. Following its annual re-balance in December, these four sectors underpinning Trump’s pro-growth agenda comprise more than 70% of the weight in the ETF.
“Very high profitability on low leveraged balance sheets also make this strategy the most resilient against the rising rates backdrop.”
The risk to this strategy, according to Nossek, is that Trump’s agenda is watered down substantially. The strategy also offers a fairly low dividend yield of 2.3%, well below some of the yields available via different approaches.
Trumped
On the flipside, Nossek said investors who believe the new President will struggle to see through many of his policies should focus on stocks offering quality and security.
The consumer staples and real estate sectors were a focus for many in 2016, with the recognition that these businesses can grow regardless of the economic backdrop boosting share prices.
While valuations have soared, Nossek said their ability to generate cash and thus enhance dividends means they remain attractive, especially if Trump’s policies fall flat.
“There is enough room for these trends to run further this year, especially as following a period of valuation growth it can now enjoy some earnings per share growth in 2017 if investors stick with past winners.”
For investors keen to access this strategy, Nossek highlighted the WisdomTree US Equity Income ETF.
The risk for this trade is that the most leveraged companies in US equity markets come under strain by rising inflation and interest rates.
“At a time when inflationary pressures in the US are become increasingly self-sustaining, and with tight labour market conditions spilling over into accelerating wages, Fed policy rate tightening looms large,” Nossek said.
“Against this backdrop a 50bp or 75bps rate hike would put at risk rate sensitive sectors the US Equity Income ETF is overweight, such as real estate, utilities and telecoms.”
Nonetheless, with a starting yield of 3.7%, the US Equity Income index, the sector allocation of which is broader and more evenly spread than US Quality Dividend growth offers a cushion for investors concerned some sectors may be overheating.
Mixed picture
There is, of course, a middle ground whereby neither extreme materialises, and in this scenario Nossek says focusing on US small caps could be the best solution.
Small caps enjoyed very strong returns in 2016, outstripping the wider US market. The Russell 2000 Index rose 20.8%, while WisdomTree’s Small Cap Dividend Index gained some 31.4%.
Following such standout returns, WisdomTree’s Small-Cap Dividend Index has seen substantial turnover, with around a quarter of its holdings overhauled. The strategy now offers a dividend yield of 3.6%, with a focus on some sectors likely to benefit from Trump’s policies. These include secular growth plays in the industrials and real estate sectors.
“The opportunity here for investors is two-fold” said Nossek. “There is the relatively high dividend available, while investors are also getting exposure to sectors which could benefit from some of Trump’s proposed plans.”
The risk for small caps is the elevated valuations. With the sector on 25 times earnings on average, there is little room for companies to miss expectations, and much of the “Trump effect” has already been priced-in.
“Any retrenchment from Trump puts the valuation premium over the broader US equity market at risk,” Nossek added.