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Trump and portfolio impacts


petec
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I'm not changing anything for now. Of course the post election rally made buying things more difficult. So I took the foot of the pedal in buying banks for example. But that has more to do with price/value rather than the election.

 

In my view you can't make any changes until you see what policies he will actually implement before you do anything.

 

For example if the infrastructure bill passes that is very good. But if he passes top heavy tax cuts that won't be very good. Then it gets to the implementation. His proposals would blow a titanic size whole in the deficit. So they're probably going to be scaled down. Also there have to be some cuts somewhere. If the cuts come from social security/medicare (very popular idea with congress republicans) or if health care costs start to get out of control then there will be impacts. Consumer products is probably one sector that's gonna be first to get hit with others to follow.

 

But for now all we can do is sit and wait.

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Consumer products is probably one sector that's gonna be first to get hit with others to follow.

 

 

Because they have traded as bond proxies, or why?

 

One thing that intrigues me is that gold stocks have sold off despite (I would have thought) a higher inflation outlook.

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petec,

 

If you go to the "Fairfax Financial" forum/section from the board index, you will se an arrow pointing to the right at the right side of your screen in line with this topic, because you are OP. If you hover the arrow with your cursor, a popup tells you: "Move topic". ; - )

 

- Just saying, to help a fellow board member. ; - )

 

-There is no better service than self service, It's a part of the whole idea of having this board running as a Simple Machine Forum [GPL attitude at its finest].

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petec,

 

If you go to the "Fairfax Financial" forum/section from the board index, you will se an arrow pointing to the right at the right side of your screen in line with this topic, because you are OP. If you hover the arrow with your cursor, a popup tells you: "Move topic". ; - )

 

- Just saying, to help a fellow board member. ; - )

 

-There is no better service than self service, It's a part of the whole idea of having this board running as a Simple Machine Forum [GPL attitude at its finest].

 

No need to apologise, I appreciate the advice, but all I can see is the arrow that takes me to the last post.

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I probably agree with rb.

 

I raised cash after election.

 

IMO the euphoria is overdone. The market overall is still at high level. And we are still at 7th year of expansion (BTW, I don't believe in cycles per se, but there's some risk the longer expansion goes). What actual changes will be done is not so clear. Some changes might be recessionary.

 

So I went to something above 20% cash from ~17% cash. I think that's where I want to be in current situation. I also cleaned up portfolio a bit. I think it was a good time to do this (rather than doing it during a crash/downturn).

 

 

 

Sanjeev, please move this thread to general! :)

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Consumer products is probably one sector that's gonna be first to get hit with others to follow.

 

Because they have traded as bond proxies, or why?

 

One thing that intrigues me is that gold stocks have sold off despite (I would have thought) a higher inflation outlook.

Oh maybe the stock prices will go down cause they have traded as bond proxies. I don't have a view on that. I was talking more toward the fundamentals of things.

 

The fact is that household budgets are strained already. If you apply additional strain because of let's say a bump in health care costs (but it could be anything SS cut, whatever). Then households have two options:

 

One, they can lever up. This could happen, but households are already in delevering mode and additional strain could actually blow the other way and push them to delever even more. Again not good for aggregate demand and for the economy.

 

Two, they cut from elsewhere. Consumer products is an easy place to start: use less(lower volume), switch to a lower brand (lower margin), oh and forget about price increases. But I brought up CPGs because it's an obvious place of impact. Other areas will be affected as well: consumer durables (keep that old car longer, we don't need a new washing machine), also lower corporate investment in reaction to soft aggregate demand, etc.

 

I'm not worried at all about higher inflation. I think it'll be great if they can actually achieve higher inflation, but it's not a problem at all.

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Consumer products is probably one sector that's gonna be first to get hit with others to follow.

 

Because they have traded as bond proxies, or why?

 

One thing that intrigues me is that gold stocks have sold off despite (I would have thought) a higher inflation outlook.

Oh maybe the stock prices will go down cause they have traded as bond proxies. I don't have a view on that. I was talking more toward the fundamentals of things.

 

The fact is that household budgets are strained already. If you apply additional strain because of let's say a bump in health care costs (but it could be anything SS cut, whatever). Then households have two options:

 

One, they can lever up. This could happen, but households are already in delevering mode and additional strain could actually blow the other way and push them to delever even more. Again not good for aggregate demand and for the economy.

 

Two, they cut from elsewhere. Consumer products is an easy place to start: use less(lower volume), switch to a lower brand (lower margin), oh and forget about price increases. But I brought up CPGs because it's an obvious place of impact. Other areas will be affected as well: consumer durables (keep that old car longer, we don't need a new washing machine), also lower corporate investment in reaction to soft aggregate demand, etc.

 

I'm not worried at all about higher inflation. I think it'll be great if they can actually achieve higher inflation, but it's not a problem at all.

 

I thought the whole point of the tax cut was to stimulate demand (and jobs).

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petec,

 

If you go to the "Fairfax Financial" forum/section from the board index, you will se an arrow pointing to the right at the right side of your screen in line with this topic, because you are OP. If you hover the arrow with your cursor, a popup tells you: "Move topic". ; - )

 

- Just saying, to help a fellow board member. ; - )

 

-There is no better service than self service, It's a part of the whole idea of having this board running as a Simple Machine Forum [GPL attitude at its finest].

 

No need to apologise, I appreciate the advice, but all I can see is the arrow that takes me to the last post.

 

If you open the thread, you should see "Move topic" button at the bottom left of the page (not sure if you have to be on the last page or first page). I see that for a thread I have opened.

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I thought the whole point of the tax cut was to stimulate demand (and jobs).

Well in theory yes. But the distributional impacts can be huge. It has to do with the marginal propensity to save and marginal propensity to consume. Let me use so simple/crude examples. I know there's issues with them because of simplicity but should provide some ideas.

 

So i am in a high tax bracket. I buy pretty much whatever I want, I have nice things and I save quite a bit of money. If you give me a tax cut, I'll say thanks and save it, or most of it. Now go to Romney's 47% (not sure if the number is 100% correct) who pay no taxes. They won't get a tax cut. In fact if benefits are cut to pay for the tax cut, they're effectively getting a tax increase.

 

Now because my budget is not strained I'm not that responsive to the tax cut. But the 47% who's budgets are strained will be very responsive to a benefit cut. There's likely not a lot of difference in the amount of ketchup i consume and the amount of ketchup the 47% consumes. And next year I'll buy roughly the same amount of Heinz ketchup as I did this year. But a strained household when faced with an adverse effect i way more likely to quickly switch to a store brand or consume less. That's not great news for Heinz.

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If you save it where do you think it goes?  Stock market & real estate.  This is what happened under Reagan.  Also I think you are going to have the momentum of bond investors who are losing money switching to stocks like what happened in 2013.  This may be in part why FFH lowered the hedges to 50%.

 

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If you save it where do you think it goes?  Stock market & real estate.  This is what happened under Reagan.  Also I think you are going to have the momentum of bond investors who are losing money switching to stocks like what happened in 2013.  This may be in part why FFH lowered the hedges to 50%.

 

Packer

So we should get excited about a run up in asset prices without improvements in fundamentals?

 

The Regan comparison is not good. Regan came in at a time when the stock market had a horrible run and valuations were low. In Jan 1983 the S&P PE was 11.5. Trump's coming in after a great stock market run. S&P PE is around 25 now I think. During Regan's time interest rates mostly went down. Rates are at the bottom now.

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Also in Reagan's time interest rates were at 12.4% & the ERP 5.1% per Damodaran vs. today interest rates at 2.3% and the ERP 6.1%.  The average ERP is around 4%.  So if we get back to the average ERP you have an upside of 15.9/11.9 or 33%.  This does not factor in lower tax rates a real fundamental cash flow impact.

 

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Banks and insurance are still cheap relative to their historical valuations and the market, even after the recent bump.  Plus, they've been hated for almost a decade now and have the tailwind of rising rates for reinvestment of bonds or loaning to customers.  I see them as a great multi-year hold at this time and would expect many of them to have large gains (doubles, etc) over that period.

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Also in Reagan's time interest rates were at 12.4% & the ERP 5.1% per Damodaran vs. today interest rates at 2.3% and the ERP 6.1%.  The average ERP is around 4%.  So if we get back to the average ERP you have an upside of 15.9/11.9 or 33%.  This does not factor in lower tax rates a real fundamental cash flow impact.

 

Packer

You can pull Damodaran and quantsy estimated ERP as much as you want. I'm looking at two situations. Situation 1: P/E=11.5, low margins by historical standards, and declining interest rates. Situation 2: P/E=26, high margins by historical standard and rising interest rates. As an investor I find situation 1 much more appealing compared to situation 2.

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If you can forecast interest rates better than the marker all the power to ya.  I know I cannot.  The ERP is valuation metric that measures the relative pricing of stocks & bonds independent of interest rates.  Stocks are worth more with lower interest rates and one way to see if stocks are overvalued in comparison to bonds is to use the ERP.  In addition, the tax reduction benefits will more than offset any decline in "peak" margins.  For example, if US rates are reduced from 40% to 25%, like other OECD countries, it implies an increase in AT margins by 25%.  Also there will be increased demand from high tax bracket due to tax cuts and foreign cash repatriation.

 

Packer 

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Banks and insurance are still cheap relative to their historical valuations and the market, even after the recent bump.  Plus, they've been hated for almost a decade now and have the tailwind of rising rates for reinvestment of bonds or loaning to customers.  I see them as a great multi-year hold at this time and would expect many of them to have large gains (doubles, etc) over that period.

 

Hi, can any of you please compare banks vs. insurance in a rising rate environment? Similarities and differences?

 

Thanks.

 

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If you can forecast interest rates better than the marker all the power to ya.  I know I cannot.  The ERP is valuation metric that measures the relative pricing of stocks & bonds independent of interest rates.  Stocks are worth more with lower interest rates and one way to see if stocks are overvalued in comparison to bonds is to use thei ERP.  In addition, the tax reduction benefits will more than offset any decline in "peak" margins.  For example, if US rates are reduced from 40% to 25%, like other OECD countries, it implies an increase in AT margins by 25%.  Also there will be increased demand from high tax bracket due to tax cuts and foreign cash repatration.

 

Packer

Why will be so much increased demand from the high tax bracket? Are they budget constrained? Are there things the cannot buy but now that they'll get this tax cut they'll go ahead get that? There's no question that there will be some increased demand but MPS is strongly correlated with income and MPS is high at the top tax bracket. So it won't push demand up a much. Then you must account for distributional effects of how you pay for the tax cut.

 

As opposed to rates I brought them up cause you mentioned the stock markets movements during Regan's time. If we have hindsight on stock prices we should have hindsight of rates. But even if you want to do it blind I have more certainty. If I was in 1983 rates could go up, down or stay the same. If I am in 2016 rates can go up or stay the same, they can't go down significantly because they don't have where to go.

 

On corporate taxes, yes US statutory federal corporate tax is 35%. But the effective corporate tax rate is 14%. That's already lower than most of the OECD, but it doesn't matter for our discussion. Let's say that Trump lowers it as promised from 35% to 15%. The most you can expect is a 7% drop in the tax rate as opposed to the stated 20%. Though it will probably be lower - again because of distributional effects. You also have to assume that these tax changes are permanent and that the next democrat president won't reverse them - but that's a more relative thing.

 

Then there's also the issue of whether these cuts will come to pass. You have a large income tax cut, a large corporate tax cut, and a large infrastructure program. Even if you increase the deficit, something's gonna have to give. Is the US planning to retire the Navy or something?

 

So no, based on current valuation levels I am not very enthusiastic that the market will go on a tear that will last.

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I think you framing of interest rate changes is missing something.  What is important is not the absolute changes in rates but the relative change.  Values will double if rates go from 12% to 6% or 3% to 1.5%.  The other thing about interest rates is they do not mean revert they go up and down over long period of times in waves.  The current cycle began in 1980 so it is 36 years old.  The last two long term cycles were about 80 years in duration.  The Victorian deflation ran from 1820 to 1900 and the Great Reflation from 1900 to 1980.  These are described in The Great Wave.  So we are about half way through this cycle so comparing PEs now to 1980 is comparing apples & oranges as the interest rates environment is completely different.

 

As to increased demand I think that what is missed is where will the wealthy savings go?  Will it go to bonds that yield 1 or 2% or stocks that yield more? I think stocks. 

 

As to corporate tax rates in most studies I have seen the effective rates range from 25 to 30% averaging around 27%.  So I think the drop will be 10%+.  As to retiring the Navy, I would not put a massive cut back on overseas deployment as out of the range of possibility & a resulting decline in the defense budget. 

 

I think these are some of the reasons Fairfax has become more bullish.  You are correct that valuation is high compared to history since 1980 but the underlying assumption is you are expecting interest rates to be the same to make the comparison valid.  I do not think the 1980s interest rates will return for a long time so I use the ERP to gauge equity valuations versus P/Es which include both interest rate and ERP forecasts.

 

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