Guild Investment Management, December 1, 2016, Executive Summary

Executive Summary

1. Don’t fear a wholesale trade war. Trump picks a turnaround king for Commerce Secretary. President-elect Trump’s pick for Secretary of Commerce is encouraging: Wilbur Ross, a seasoned investor who has made a career finding and turning around left-for-dead companies, especially in industries hit hard by offshoring. He has long shared Mr. Trump’s critical stance toward badly negotiated trade deals that have hurt American workers. His appointment makes us continue to believe that the Trump administration will not be anti-trade, but will be in favor of intelligently negotiated trade deals, and that its policies will help bring jobs back to middle America. We remain bullish on U.S. banks and industrials.

2. Italy’s referendum may inspire European regulators to kick the can once again. Italian voters go to the polls for an important referendum this coming weekend. Italy’s weakest banks could see their current market-based rescue plans scuppered if Italians deliver a “no” in the vote. If the Italian government had to step in to save these banks, holders of the banks’ bonds would have to be “bailed in” under current EU rules. That would hurt millions of ordinary Italian savers who have long held bank bonds, naïvely thinking them to be extremely safe investments. We suspect that if the vote fails and the banks are in jeopardy, Italian and EU regulators will do what they do best: cobble together a solution to put off the inevitable for a little longer, rather than risk the ire of Italian voters in next year’s elections. In any event, seeds are being sown for future troubles in European banking and politics, even if the immediate aftermath of the vote is not
as dire as media are predicting.

3. Market summary. Our favorite market at this juncture is the U.S. First key point: a very strong U.S. dollar is creating strong demand for U.S. stocks in several industries. Second key point: avoid U.S. bonds and high-yielding stocks — interest rates will rise, and bonds and high-yielding stocks will fall in price. President-elect Trump’s stated goal is to increase the growth rate of the U.S. economy, the growth rate of U.S. corporate profits, and the growth rate of income and living standards of the U.S. populace at large. Accordingly, investors may enjoy an excellent continuing opportunity in several sectors and industries: industrials, financials, energy transportation, truckers and rails, discount retailers, and some new social media and communications technologies. Focus on groups which can grow rapidly as U.S. growth accelerates. Only buy on dips — don’t chase stocks that have run up.

Trump Taps a Turn-Around King

The Secretary of Commerce acts “as the voice of U.S. business within the President’s Cabinet.” Trump’s pick for the post, Wilbur Ross, tells us something about the President-elect’s psychology.

Mr. Ross has bought and restructured steel, coal, telecom, and textile firms during a forty-year career as a banker and investor. He has made his fortune turning around left-for-dead companies — particularly in U.S. industries hit hard by the “bad trade deals” whose criticism garnered critical support for Mr. Trump during his campaign. More recently, he has searched for bargains and opportunities in down-and-out European financials. Most important, he shares Mr. Trump’s conviction that crafting good trade deals is critical for the revitalization of American industry, and has long been a vocal critic of deals he views as damaging.

We’re encouraged that such an experienced and tough negotiator and speculator will be on Mr. Trump’s team. He is clearly not a man who is opposed to trade, but one who is opposed to badly negotiated trade deals that are disadvantageous for U.S. industries and workers. What we have seen him say — for example, that every trade deal should have a built-in “re-opener” to fine tune after five years — encourages us that if his influence prevails, the results will bring industrial employment back to the U.S. and improve the fortune of middle America’s blue collar workers.

We’ll carefully monitor his policies and proposals as we continue to evaluate the U.S. growth path under the Trump administration.

Investment implications: President-elect Trump’s pick for Secretary of Commerce is encouraging: Wilbur Ross, an investor who has made a career finding and turning around left-for-dead companies, especially in industries hit hard by offshoring. He has long shared Mr. Trump’s critical stance toward badly negotiated trade deals that have hurt American workers. His appointment makes us continue to be optimistic that the Trump administration will not be anti-trade, but will be in favor of intelligently negotiated trade deals, and that its policies will help bring jobs back to middle America. We remain bullish on U.S. banks and industrials — but only on dips.

Italian Referendum May Inspire European Regulators to Kick the Can Once Again

This coming weekend, Italians go to the polls to make their judgment of Prime Minister Matteo Renzi’s push for constitutional reform. We’ve written about this referendum and its importance several times recently. Media are focusing on eight weak Italian banks whose current rescue plans could be challenged if voters say “no” to the proposed reforms.

Mr. Renzi has pledged to resign if these reforms are rejected. (Polls, as well as the apparent anti-establishment momentum in popular opinion around the developed world, suggest that the Italians will vote “no.”) If he does, that probably means new elections and a new government, perhaps after an interim where the government is run by appointed technocrats: but forming such a government will take time and could cause some market uncertainty. This is especially true because the winners of eventual elections could be populist and Euroskeptic parties of both the left and right wings, the Lega Nord and Five Star Movement.

Market uncertainty could scupper Renzi’s current efforts to find a market-based solution to deal with eight of Italy’s distressed banks. (Italy’s banking sector is by far Europe’s weakest, and the most weighed down with non-performing loans, due to successive governments failing to implement needed reforms and recapitalizations.)

If the banks had to be “resolved” by the government under current EU rules, millions of ordinary Italian holders of those banks bonds would have to be “bailed in” — having their bonds exchanged for bank stock which would probably plummet in value. Needless to say that would make a large number of very unhappy voters, something Italy’s current government would be eager to avoid, since those voters would be more inclined to cast ballots for Euro-skeptic and populist disruptors when they choose the current government’s successors.

We suspect that a “no” vote will evoke the now-traditional European response: a stop-gap measure to deal with the immediate aftermath of the vote, to calm the populace, and to delay the decisive action needed to actually address the underlying problems. Longer-term, seeds are being sown for further troubles in the Italian and European banking sectors.

Investment implications: Italian voters go to the polls for an important referendum this coming weekend. Italy’s weakest banks could see their current market-based rescue plans scuppered if Italians deliver a “no” in the vote. If the Italian government had to step in to save these banks, holders of the banks’ bonds would have to be “bailed in” under current EU rules. That would hurt millions of ordinary Italian savers who have long held bank bonds, wrongly thinking them to be extremely safe investments. We suspect that if the vote fails and the banks are in jeopardy, Italian and EU regulators will do what they do best: cobble together a solution to put off the inevitable for a little longer, rather than risk the ire of Italian voters in next year’s elections. In any event, seeds are being sown for future troubles in European banking and politics, even if the immediate aftermath of the vote is not as dire as media are predicting.

Market Summary

The U.S.

Our favorite market at this juncture is the U.S.; for that reason, this summary will focus on U.S. stocks and bonds and world currencies.

First key point: A very strong U.S. dollar is creating strong demand for U.S. stocks in several industries.

Second key point: Second key point: avoid U.S. bonds and high-yielding stocks — interest rates will rise and bonds and high-yielding stocks will fall in price.

U.S. Stocks: Growth is the Mantra

President-elect Trump’s stated goal is to increase the growth rate of the U.S. economy, the growth rate of U.S. corporate profits, and the growth rate of income and living standards of the U.S. populace at large.

His proposed plans indicate to us that he may experience success in part of this undertaking. Accordingly, investors may enjoy a continuing opportunity in several industries. Below are our favorite investment sectors, but we believe all stocks should be bought on dips.

1. Industrials. Particular beneficiaries could include manufacturing companies, especially those with a connection to defense or to infrastructure. Defense spending will rise, but we doubt that military action will rise. We would not be surprised to see less military action while there is buildup of aircraft and ships. Infrastructure spending will consume cement, steel, and energy. We favor steel among infrastructure industries.

2. Financial stocks. In the U.S., we have seen years of increasing financial regulation, much of it oriented toward big banks and institutions. This regulation, while doing some good, has unintentionally penalized small and regional banks. This regulation will be dialed back, allowing regional banking institutions, insurance companies, stock brokers, and credit card issuers to benefit.

3. Energy transportation (with a caveat, see below) will be freed up, and more pipelines will move more oil, gas, and refined products, some of which will be exported. A potential negative that one must consider when investing in this industry is that the energy transportation companies are often yield-oriented and may be hurt by the expected rise in interest rates over coming months.

4. Transportation. Truckers may benefit, as more trade will be handled by U.S.-based truckers, and Mexican truckers who have received special treatment will lose their special dispensation. Railroads would be our second choice within transportation.

5. Retail continues to be an especially competitive industry with many cross currents. In our opinion, discount retailers should outperform their non-discount competitors.

6. Technology. In this sector, innovation and productivity increases will meld with changes in the way in which advertising, media, and many other business sectors are being quickly transformed. Social media and new communications technologies will be the change agents. Avoid traditional media companies. Invest in change-agent companies in technology and social networking.

Increased demand for U.S. stocks arises from two sources.

1. Investor inflows from around the world as those who want to see their assets grow are attracted by a strong U.S. dollar and rising stock prices. Investor flows are rapidly returning to the U.S.; we see more money coming into U.S. stocks and more money leaving U.S. bonds. According to Lipper as cited by the Institutional Strategist, “U.S. equity inflows totaled $28 billion in the week ended Nov 16th while bond outflows totaled $18 billion.” In our view, these kind of flows will keep U.S. stocks moving ahead for some time to come.

2. Due to lower corporate taxes, firms will earn more, and we anticipate that further growth will encourage a larger and more prolonged economic optimism among business and consumers. We note that current consumer optimism has increased substantially since the election as measured this week by the University of Michigan’s Current Economic Conditions survey and the Conference Board Consumer Confidence Index.

The Risks

1. The dollar has been very strong; if it gets out of control and begins to move up in a volatile and unsustainable manner we will see stock market corrections.

The DXY Dollar Index Has Strengthened Rapidly
Source: Bloomberg

2. Europe has a very undercapitalized banking system. A crisis among European banks will create a global market correction.

Longer-term, as long as the growth agenda is in force, we will see growth in U.S. stocks. Focus on groups which can grow rapidly.

An acceleration in economic growth will come primarily from the U.S., while China continues its current vigorous growth.

Global Currencies

All major countries are devaluing their currencies against the U.S. dollar; therefore:

First, hold your cash in U.S. dollars.

Second, if you buy any stocks, real estate, or other assets denominated in a foreign currency, try to hedge that currency to the U.S. dollar.

Thanks for listening; we welcome your calls and questions.

Tim Shirata
Executive Vice President
Guild Investment Management, Inc.

12400 Wilshire Blvd. Suite 1080
Los Angeles, CA 90025
Tel: (310) 826-8600 Fax: (310)826-8611
email: tshirata@guildinvestment.com

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