The market falls, and the headlines suggest investors now have some doubt about the "Trump trade." Gee whiz, who could've thought?
Sarcasm aside, there's a real irony in the market's nearly unchecked rise even as the least-popular President in postwar history continues his amateur-hour chaos. For how long have we been told investors crave certainty, only to watch them pile into the market in the past four-plus months in the face of unprecedented instability in the White House?
It's not to say, of course, that there aren't certain "Trump themes" in investing today. I have a few of them here today, for your consideration. If you think we're in the early days of a paradigm-shifting presidency, by all means consider these as recommendations. On the other hand, this could also be a nifty list of stocks to avoid – or even short, if you share my views of Mr. Trump's incompetence and the frothiness of the Trump bump.
With coal miners in hard hats surrounding Mr. Trump as he eviscerated the U.S. climate-change laws, look next for them to gather around the bell at the New York Stock Exchange for a series of initial public offerings.
Ramaco Resources Inc., a Kentucky-based miner of Appalachian coal, went public in February, and Alabama coal miner Warrior Met Coal Inc. has filed for its offering. The Wall Street Journal reported in February that at least a half dozen coal companies were talking to investment bankers about selling stock to investors, which would make 2017 the best year for coal IPOs in … maybe ever. (The WSJ said its data went back to 1995, and no year featured more than four.)
There are non-Trump reasons for this explosion: The price of metallurgical "coking" coal, used for steel, tripled in 2016 after production cutbacks choked supply. But while coal stocks are up over all since Mr. Trump's election, a sharp pullback in coking coal prices in 2017 has blunted their performance, year-to-date.
Ramaco debuted Feb. 3 at $13.50 (U.S.), having snagged the ticker symbol METC (for metallurgical coal) away from any producers that may follow. It traded as high as $14.78 on its first day, but neatly lost more than 40 per cent of its value by early this week.
It has rebounded since, but the skeptics are on to something: A big chunk of shares in the Ramaco offering were sold by pre-IPO shareholders, and some of the money the company raised by selling stock went to pay off debt owed to its owners. Many of the coal companies eyeing IPOs, including Warrior Met, are backed by private-equity funds or similar wealthy shareholders who swooped in when coal miners went bankrupt just a few years ago, having overspent on capacity right before a drop in coal prices. These big-money investors seem to have their timing right by selling now; you may not, by buying.
Mr. Trump's promise to repeal Obamacare and replace it with "something terrific" imploded as Republicans devised something distinctly unterrific. No matter, he says – on to tax reform! It should be entirely possible that the Republican Congress and the Republican President can devise a tax-reduction plan that cuts corporate taxes and boosts profits, thereby somewhat justifying the equity run-up since November. It might be, though, that the poor market performance in the first couple of sessions after the health-care disaster suggests investors think this motley crew can mess up this slam dunk as well.
Let's get micro and technical, however, and examine one element of a change to tax law that's under consideration by Mr. Trump and the Congress. The proposal would prohibit companies from deducting interest expense from their pre-tax earnings. In exchange for the loss of this deduction, they would be allowed to deduct capital investments instead.
S&P Global Market Intelligence notes that S&P 500 companies deducted $172-billion in interest expense and $209-billion in depreciation expense from pre-tax earnings in 2016, a total of $381-billion. They spent $630-billion on capital expenditures, by contrast, suggesting a win for companies and a loss for the U.S. Treasury, depending on what capital investments are ultimately deemed deductible.
What's important for investors, however, is to realize that the change is good for some industries and bad for others. To get a sense of this, S&P Global Market Intelligence has chopped up the interest expense and capital expenditures by industrial sector. A sector that has a bigger share of interest expense than it does capex is a likely loser in this proposed tax change, while interest-light but capex-heavy sectors are the winners.
Specifically, says S&P Global Market Intelligence: in 2016, companies in the health-care sector deducted 12 per cent of the interest expense deducted by all companies in the S&P 500, but made only 5 per cent of the capital expenditures. My examination of five years of the data suggests financials are the runner-up loser, as they also typically have twice the share of interest deductions to capex, followed by consumer staples in a distant third.
Winners? Companies in the energy sector deducted only 8 per cent of the total interest expense deducted by all companies in the S&P 500, but made 15 per cent of the capital expenditures. Information technology companies, over the past five years, tended to have half the share of interest deductions compared with capex.
Finally, just for kicks, I responded to one of those spammy investor e-mails that promised "7 Top-Rated 'Trump' stocks to Buy Now!" ("Dear Fellow Investor, The Trump Era has begun with the kind of promise that is quickly turning naysayers into converts. At the very least, it has them reconsidering their opposition to the president.") HA! Anyway, the list seems to contain just six stocks, not seven, symbolizing the overpromise-underdeliver ethos of the current administration. The recommendations? Uniform company Cintas Corp., private-prison company Geo Group Inc., United Rentals Inc., Caterpillar Inc., coal-bearing railway CSX Corp., and Murphy Oil Corp.
All of these companies have any number of things to recommend them, and the U.S. and global economic backdrop may ultimately help deliver gains to their investors. But for the newsletter's assertion that they are "so unstoppable, they're almost guaranteed to power higher from the Trump administration and his big infrastructure promise"? Folks, there are no guarantees in the Trump administration save instability. Trade Trump accordingly.