The Trump Administration Won’t Help These Companies At All

The Trump stock market rally paused last week while bonds continued their post-election sell-off and the dollar its post-election rally.  All three major stock market indices lost a little ground with the Dow Jones Industrial Average ending the week at 19,843.41 after trying to hit the completely meaningless 20,000 mark (CNBC had the balloons and buttons ready and may well get to use them), the S&P 500 closing at 2,258.07 and the Nasdaq Composite Index finishing at 5,437.16.   In contrast, the yield on the benchmark 10-year Treasury ended the week at 2.6% and the US Dollar Index (DXY) traded as high as 103.56 on Thursday before ending the week at 102.81.  Higher yields and a stronger dollar are serious headwinds for US corporate earnings and there is little sign that they will reverse direction any time soon.

Moreover, Trump’s proposed corporate tax cuts may not help as many businesses as people think.

I told you last week that I’d be cherrypicking some long plays during the Trump rally, since it makes no sense to throw perfectly good money down the drain. Today, I want to show you the flip side of the coin.

Here’s why Trump may be bad news for these companies – and how you can profit.

Trump And Yellen Are Teaming Up To Kill Junk Bond Companies

The yahoos in the Marriner Eccles Building actually raised interest rates for the second time in ten years last week.  The market decided it didn’t like it on Wednesday, then did like it on Thursday, and then was just bored with the entire affair on Friday.  Listening to Janet Yellen at her press conference was not only incredibly boring but also profoundly depressing as it revealed once again that the most powerful central banker in the world not only can barely string two coherent sentences together but also has no clue what is happening in the American economy.  Instead, she still thinks the Fed can day-trade the economy back to health when it should be simply getting out of the way.

The problem, of course, is that the Fed waited far too long (at least two years) to start raising rates and the economy is so over-leveraged that normalized rates (i.e. a Federal Funds rate of 2%-2.5%) would cause serious problems for public and private sector borrowers.  With the global debt-to-GDP ratio at 235%, the economy will have trouble handling significantly higher rates.  On the other hand, low rates are suppressing growth.  The global economy can’t grow fast enough to service and repay the more than $200 trillion of debt sitting on its balance sheet.  So the world is facing the unhappy choice of having to rid itself of its excess debt by defaulting on some of it (see under Puerto Rico and many states and cities to come like Illinois, Chicago, New Jersey, California as well as many corporations) and inflating the rest away (through traditional inflation or currency debauchment).

Yellen’s higher rates, plus Trump’s proposed tax cuts, are positioned to deal a serious blow to the high yield sector. Here’s why.

Investors should keep in mind that most highly leveraged companies in the junk bond market pay little or no taxes (because they have little or no earnings), so any corporate tax cut coming from the Trump administration won’t help them while higher interest rates will hurt them.  Accordingly, the struggle we are going to see in the US corporate sector between lower tax rates and less regulation on the one hand and higher rates and a stronger dollar on the other will deliver different benefits to different companies.  But for many leveraged companies, the impact is going to be decidedly negative since the tax cuts won’t have any impact while higher interest rates will be a serious problem.  Overall, the impact of the Trump agenda on corporate earnings may end up being only marginally beneficial to US stocks depending on the timing and size of tax cuts, the degree to which interest rates ultimately rise, and the speed at which regulations are cut back.

For investors in bonds, of course, higher rates are an unmitigated disaster.  Rates are not only rising in the US; European and Japanese interest rates are sharply higher since the election though still at very low levels.  The Japanese bond market is a train wreck and the US market is not far behind.   The 10-year yield has basically doubled since its post-Brexit low last August.  The most likely path from here is that rates will continue to rise (not necessarily in a straight line but pretty steadily) until they hit a level at which they cause problems for the U.S. economy (i.e. a recession and/or a bad stock market event).  Despite all the noise about strong US growth, the reality is that recent US growth has been lousy other than in the third quarter of this year.  It is going to take a strong fourth quarter to salvage 2016 as anything other than a terrible year for growth eight years after the end of the financial crisis.  Why anybody should expect anything else in the face of higher taxes and mountains of additional business-crushing regulations from the Obama administration is no mystery to me, but apparently it is a complete mystery to the mainstream financial press and the Federal Reserve.

In order to profit, I recommend that you buy puts on the Vanguard Total International Bond ETF (NASDAQ: BNDX) and other high grade bond ETFs.  High grade bonds are going to do much worse than high yield – I think high yield is going to be ok for a while despite higher defaults, and I don’t think it is a compelling short. However, investment grade and sovereign debt with very low coupons and long maturities are going to get killed, so I recommend shorting those kinds of ETFs.

18 Responses to “The Trump Administration Won’t Help These Companies At All”

  1. Hello! I’m 83 years old, with two very intelligent sons, 16 and 18 years old. Our 18 year old son is in a Military University, doing very well. Our 16 y. o.is a Jr in high school. national honor society, etc. Our 18 y. o. is doing very well. Freshman Cadet GPA is 70. Our `18 y. o. son has an 88 GP. All of our money is tied up with a financial advisor, and our average income (on paper) is very small. What should we expect to profit from some $ 350,000 invsted in stocks,etc over several years with this advisor? Thank you!

  2. One reads frequently in criticisms of the Fed that they don’t know what they’re doing, but I think this is a mistake. Yellen takes her orders from the big investment Wall Street banks that own the Fed. They don’t give a damn about the impact of policies like QE on the overall economy, only on their bottom line. What they’ve been doing has made them even more obscenely rich (at the expense of people who actually work for a living) than they already were. Their policies have met their real goal.

  3. I wanted to reply to H. Garey rather than ask my own question:

    “Better late than never!”, brother. I’m 66 and have a 14 year old son and a 10 year old son. And I thought I was late!
    You are betting on one horse, and track conditions are now subject to radical change. Even a past record of success by this advisor is no guarantee of future success. I would be very, very leery of putting more than 10% of my eggs in his or her basket without supreme confidence that you have zero hope of ever comprehending half of his or her forecasting abilities and grasp of the Big Picture. Most assets are over-valued, so if he/she is mostly long I would diversify without delay.

    They say “You can’t teach an old dog (like you and I) new tricks.”, but I disagree under one condition: That we turf all TV sets in our home. If there is one thing you teach your sons, that might be the most valuable thing, in terms of them actually understanding the world they live in. You can’t even put a money tag on it, it’s so priceless.
    Cheers!

  4. BNDX option chain is quite illiquid. Wide bid- ask pricing and very little open interest. That could change if the fund heads south, but is not likely to peak much interest in the markets.
    Mr Garey- know your risk vs reward going ahead with your portfolio. Ask the advisor that question. Geopolitical events can change markets attitude, make sure you can absorb the bumps.

  5. Everyone must think Trump is the savior. Even the crap companies are doing OK for now. How long can this go on? I’ve lost on many short positions since the election, but I think at some point the crap companies will go down. Many people are ignoring the hard facts. When does fantasy become reality?

  6. On this site I expect most folks are genuinely worried about what will happen. If you fit in this group, I suggest you spend some time with several advisors and take in their strategies and forecasts beforehand. Then decide. I would further suggest you think about your egg not as a lump sum but 5, 7, or 10 sums that will be invested in different
    uncorrelated or less correlated assets. Geopolitical risks are high as Tim B. points out,and I will go a step farther- avoid buying into things that have already gone up-
    look at commodities, hard assets, emerging markets equities, and their bonds, and precious metals as some of the less correlated assets to dollar based assets.
    You can also gift your sons up to $10k per year with no tax consequences, and there are times that’s money better spent. Everbank is a firm I used to buy foreign CDs, bonds and to buy precious metals. I know of no other bank that offers this. Just add .com to their name. That could be a great gift,and you can set up accounts they receive when they reach 21, or 25 (if they were less mature).
    choose wisely.

  7. “Investors should keep in mind that most highly leveraged companies in the junk bond market pay little or no taxes (because they have little or no earnings), so any corporate tax cut coming from the Trump administration won’t help them while higher interest rates will hurt them… But for many leveraged companies, the impact is going to be decidedly negative since the tax cuts won’t have any impact while higher interest rates will be a serious problem.”

    Under the logic above, high grade bonds should perform better than high yield bonds, right?

  8. I follow your column, and today you focused on an unsustainable rally for stock. I have my money in a GIC guaranteed investment certificate portfolio and even though it is a safe parking space, it does not yield much 1.05 %. When these mature in feb I plan to transfer the capital to US equities . Is this wise ? Please advise

  9. Robert Lee Hawthorne Jr

    A Trump tax cut will big for small business. I am a small business owner with over $500,000 a year income. I now pay over 50% tax, federal and state. A reduction to 15% from 39% federal is huge for me and many other small business’. I restrict hiring because of Obama Care. Lower taxes and fix Obama care and I could grow even more.

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