Where would the value trade be without Donald Trump? It is a valid question to ask as Trump has been the driving force behind value equities since he was elected at the beginning of November.
Indeed, since the election, the iShares Russell 1000 Value Index (IWD, Financial) has risen 15%. Over the past five years, the index only added 45%, underperforming the S&P 500 by 5%. Over the past decade, it has lagged the S&P 500 by around 30%.
Value’s outperformance is only slightly due to Trump, although he has had a significant impact on economic factors that influence value’s performance.
For example, the performance of value tends to be driven by inflation and economic growth, both of which have been lackluster for much of the past decade since the crisis. With inflation picking up, value has started to make a comeback as earnings expectations rise. What’s more, since the crisis, banks and financials have featured heavily in value indexes. As a result, bank regulation, fines and falling interest rates have only held back value indexes as banks have struggled. Rising inflation expectations and interest rates have helped bank stocks recover, which has in turn lifted value indexes. (There has also been some chatter from Trump lawmakers that bank regulation introduced after the crisis will be rolled back once again, helping push bank stocks higher.) As well as financials, cyclical stocks have been pushed higher by Trump’s proposed (yet to be announced) infrastructure spending. Many cyclical stocks have been depressed since the crisis due to lackluster economic growth, and this seems to have been the catalyst they needed to take off.
Small-cap boost
Value stocks, particularly small-cap value stocks, have also received a boost from Trump’s proposed corporate tax rate cut. Small-caps tend to be U.S.-based with little in the way of international earnings, so these companies are really set to benefit from a corporate tax rate cut that will boost earnings substantially. For example, consider a company with a pre-tax margin of 10% on $1,000 and a basic corporate tax rate of 35%. Net income should come in at $65. But if the tax is reduced to 20%, net income will increase to $80, a gain of 23% assuming all else remains equal. This simple illustration explains why the iShares S&P SmallCap 600 Value Index (IJS, Financial) outperformed the S&P 500 by 10% in the weeks after the election.
It appears it really can be argued that Trump has been the biggest catalyst for value stocks in a decade. But the big question is, will it continue?
Will the rally continue?
Looking across the market at various stocks and sectors that were considered to offer value but have now benefited from the Trump bump, it looks as if there is a lot already baked into them.
The Industrial Conglomerates sector is a great example. At the time of writing, the sector as a whole is trading at a historic earnings multiple of 23.4, which looks expensive. Compared to projected earnings growth it is. The 14 companies that make up the sector are expected to grow earnings per share by an average 11.9% this year. Meanwhile, the entire Basic Materials sector is trading at a trailing price-earnings of 21.9.
These valuations may not turn out to be as pricey as they look now if Trump’s infrastructure plan comes in as expected. In this scenario, growth created, both from infrastructure spending and wider economic growth, will power earnings ahead. But what if the plan never comes in? Furthermore, if Trump is never able to introduce his corporate tax rate reductions, what will happen to small-caps then?
Trying to time the market based on political decisions or actions is almost impossible, so it is never wise to try. The Trump bump, however, raises some critical questions about the state of the market today and what the future looks like for stocks if all of the president’s promises fail to materialize.
Disclosure: The author owns no security mentioned.
Start a free 7-day trial of Premium Membership to GuruFocus.
