This article is part of a regular series of thought leadership pieces from some of the more influential ETF strategists in the money management industry. Today’s article features Mark Eshman, co-founder and CIO of ClearRock, an SEC-registered investment advisor with offices in San Francisco and Sun Valley, Idaho.
On the evening of Nov. 8, as it became crystal clear that Hillary Clinton, and not billionaire real estate developer and reality TV star Donald Trump, had virtually no electoral path left to the White House, the Dow Jones futures sold off more than 800 points.
In the next three trading days, something unexpected happened: Copper prices surged 6%, the 10-year yield jumped from 1.85% to 2.15% and the stock market gained 1.2%. All of this happened in the absence of a substantive policy speech by the incoming president, without a flurry of great corporate earnings, and not a peep from the Fed.
Based on the platform Trump campaigned on (and not much else), markets are betting on lower corporate and personal taxes, deficit spending to rebuild the nation’s infrastructure and stimulate job growth, and a more isolationist foreign policy to appease the working class voters who delivered his stunning victory. With a Republican-controlled Congress, the current thinking is that the new president can and will achieve much in a short period of time.
Certain Themes Seem Clear
Even if one assumes that a highly functioning White House, Senate and House can draft and pass into law much of Trump’s agenda over the coming year or two, this cornucopia of legislation is a very tall order.
Yet whatever Washington accomplishes in response to Trump’s ambition, it’s likely to be pro-growth, to increase the budget deficit and consequently generate higher inflation.
What does this portend for the next few months and years for the stock market, the bond market and your asset allocation? What ETFs should you own to optimize your portfolio around a Trump agenda?
Before answering these questions, it’s important to point out that economic cycles are historically somewhat predictable, in that we move from growth to slow down to credit contraction to a recession, and back again. What isn’t always as predictable is the length of each stage of the cycle.
Other Factors Than Policy
Surely one of the factors influencing this can be public policy, but other influences like global trade, technological change and geopolitical events also matter greatly.
If an administration is credited with a longer-than-usual expansionary period, it’s important to look at other factors that could be responsible. Former President Bill Clinton often is credited with the last time America had a balanced budget. (In fact, we had a surplus.)
Was the length of the expansion due to Clinton’s belief that debt reduction rather than tax cuts was the best way to stimulate growth, or was it due to the explosion of the internet and the billions of dollars of wealth created during the now-infamous dot-com boom?
On the flip side, can the entirety of the Great Recession, led by the subprime mortgage bubble, be laid at the feet of the Bush administration’s pro-homeownership policies? Or was it the sharp accumulation of household debt in the early 2000s after the dot-com bust? What impact did the horrific events of 9/11 have to accelerate the economy into a downturn?
So where should you place your ETF bets under a Trump administration? I would focus on the following three:
SPDR Bloomberg Barclays High Yield Bond ETF (JNK)
With a pro-growth agenda, Trump and Congress will want to fulfill the promises made to the folks who elected them: working class whites from the industrial heartland. Many companies in this part of the country are issuers of high yield debt.
Moreover, a good chunk of “junk” debt is currently energy-industry-related. With a commitment to building out the energy infrastructure and a promise for looser carbon regulations, the Trump administration should be kind to energy companies.
As of 11/24/16, the SPDR Bloomberg Barclays High Yield Bond ETF (JNK) has a yield-to-worst of around 6.48% and a duration of about 4.25 years, more than compensating investors for a rise in rates and any possible defaults. In fact, one point that is usually misunderstood is that a rise in rates indicates an economic expansion, something that normally is not accompanied by a wave of corporate restructurings.
iShares U.S. Aerospace & Defense ETF (ITA)
Despite the fact that the U.S. spends more on defense than the next nine largest militaries in the world combined, President-elect Trump has pledged to spend even more.
Historically, spending on our military has fluctuated between 15-20% of the annual U.S. budget. With the U.S. projected budget near $4 trillion for fiscal year 2017, any marginal increase in the percentage allocated to defense is an enormous number.
Trump has pledged to increase the number of active-duty troops in the Army and the size of the Navy, a large-scale modernization of military facilities, an increase in weapons and our nuclear arsenal, and a dramatic bump in missile defense.
The iShares U.S. Aerospace & Defense ETF (ITA) has appreciated at approximately 11% per year since 2006, including years when the budget sequester froze defense spending. With a Republican president and Congress, there’s a high probability of more, rather than less, spending on aerospace and defense.
iShares 0-5 Year TIPS Bond ETF (STIP)
Generating yield has been one of the biggest frustrations for advisors, portfolio managers and retirees alike over the past 10 years. It may therefore seem counterintuitive to see fixed-income ETFs as two of the three best ideas to buy in the wake of the Trump victory.
For reasons I’ve discussed earlier, the economy will likely extend its current expansionary phase through the incoming administration’s pro-growth policies.
In addition, data from the past quarter or two has indicated we’re heading into a period of higher inflation. For example, U.S. durable goods orders surged 4.8% month-over-month in October. Core capital goods orders and shipments also each showed stronger than expected growth.
Combined with weekly jobless claims dropping, higher wage growth and a bounce in mortgage applications, it’s not surprising to see Treasury yields over 2.25%. I like the iShares 0-5 Year TIPS Bond ETF (STIP) (short-duration TIPS) because the current yield differential is not significantly less than longer-duration TIPS, but as rates rise, the “bond” component of the TIPs won’t see as much depreciation due to its duration of 2.5 years.
Another way to look at STIP is this: Bonds are an important component of nearly all clients’ asset allocation since they are equity “risk mitigators.” We tend to buy bonds as ballast in a portfolio to help shield us from extended down periods in the stock market.
With STIP, you have something that will increase in value as inflation accelerates, and also will act more “bond like” in providing both yield and protection from falling stock prices.
What Trump can and cannot do to move the economy forward is not entirely in his control. Vestiges of previous administrations’ policies, along with the natural cadence of economic cycles, will have a significant influence as well.
Just as important will be the interplay between those “policy remnants” and any of his administration’s new initiatives. More to the point: The broader influences of long-term economic cycles may ultimately trump Trump.
Mark Eshman is co-founder and CIO of ClearRock, an SEC-registered investment advisor with offices in San Francisco and Sun Valley, Idaho. ClearRock clients currently own JNK, ITA and STIP. Contact: firstname.lastname@example.org. For a full list of disclosures, please click here.