Trump Speech 3 banks and 1 industrial to watch

Corporate America is facing less Trump pique, and key shares may even have passed ‘Peak Trump’, heading into his speech next week.

Tamer tweets, vanishing volatility

Fewer tweet attacks and easing Trump-related volatility shows hazards for shares he targets are diminishing. We back tested shares of 10 companies targeted by @realDonaldTrump between November and earlier this month. After an initial drop of 1%-7%, they have suffered negligible, if any, lasting weakness to date. More broadly, with just one full sessions before his speech, options trading points to an S&P 500 move of less than 1% in either direction the day after. That means any volatility around Trump’s address to Congress on 28th February could be tame.

Still, that might be only a small relief for companies linked to project Make America Great again, as they continue to face risks from being the focus of the President’s attention, and from a wider ramp in economic expectations. Perhaps the most obvious channel of those expectations is the dollar. Against the yen, currency of the No. 4 U.S. trading partner, the greenback is 11% higher since 8th November. For a more global gauge of that strength, we can note that the Trade Weighted Dollar Index (TWDI) compiled by the St. Louis Federal Reserve Bank rose as much as 4.8% since Trump’s election win, reflecting ‘reflation’ talk. Since 23rd December, the TWDI has softened, but is still 2.3% higher since Election Day. That takes its appreciation since mid-2014 to almost 25%.

U.S. firms may not always apply that mark-up on goods they trade, but the impact for companies that generate significant revenues overseas is unavoidable. A handful of significant names have piped up so far. Apple and Caterpillar, for instance, pinned dented guidance on the dollar’s grind. Apple, whose mostly offshore cash pile had ballooned to $246bn by year-end 2016, the highest ever, would be the prime beneficiary of changes to corporate taxation that make it easier to repatriate cash. At Caterpillar, the world’s largest construction equipment maker, dollar worries are more acute. Whilst it earned 53% of revenues outside of North America last year, its fastest-growing regions are elsewhere. Its expectation for sales and revenues in 2017 is “now slightly lower due to the strengthening of the U.S. dollar over the past two months” it said in January.

Dollar may slow Caterpillar to a crawl

Caterpillar is broadly emblematic of how aspects of ‘Trumpflation’ might—ironically—not be welcomed by large U.S. industrials. For one thing, shares in the sector have been hypersensitive to the mutability of the administration’s policy agenda thus far.  On Thursday, for instance, a report on political website Axios was linked to a sell-off of construction stocks, including Caterpillar. It said Trump was considering a delay of increased infrastructure spending till next year. Accurate or not, the story underlines risks for construction plays.

Caterpillar’s specific focus on construction equipment pressures it in other ways too. A glut of used machinery in North America is hampering 2017 sales, it said, pushing its bottom line $1.2bn into the red in the fourth quarter from a loss of less than $100m a year earlier. The group cut 7,700 U.S. jobs in 2016, and is considering closing two more major plants stateside. The group could end up being a ‘Trumpflation’ bellwether in the wrong direction. Its shares rose almost 35% last year, though have underperformed fellow Dow industrials so far in 2017.

Big beg for fin-reg de-reg

Banks are currently more on the winning end of the Trump trade. They did most of the heavy lifting that powered the Dow Jones Industrial Average to its 20,000 milestone. Goldman Sachs alone accounted for some 170 points of the market’s 42-session surge above 19,000, the largest contribution by one stock. And GS together with rival JPMorgan contributed 20% of the rise. As in construction, expectations about policy benefits for lenders were behind rises of around 30% a piece by Goldman, JPM, Morgan Stanley and Bank of America (BofA), between early November and the end of last year.

Banks have lobbied hard about the potential benefits of rolling back key regulations, many covered by the 2010 Dodd-Frank Financial Reform Act. Lenders point to the annual cost of implementing the rules, which hit $10.4bn in 2016, the highest yet, taking the total cost since 2010 to $36bn, according to Bloomberg. Once elected, Trump quickly switched from a mixture of carrot and stick strategy towards the sector, to mostly just carrot, pledging to soften Dodd-Frank.

The key flaw in mega banks’ argument however, is that for them, the costs barely hurt. It is the smaller regional lenders with narrower net interest margins that feel most pain. The larger question for the U.S. bulge bracket is whether they really need a boost from easier regulation at all. Ergo if such a boost is forthcoming will its impact be sufficient to fuel another leg of gains for their shares? U.S. banks after all, already hold the top five league-table positions in investment-banking fees, they control fixed-income trading, the biggest global business by revenue, and their lending at home is also robust.

Diminishing returns

So U.S. banks are outperforming lenders everywhere else without finreg reduction. It’s partly a function of their faster balance sheet clean-up compared to European rivals. The largest American banks now have, on average, regulatory capital ratios that are higher than those of lenders across the Atlantic. Better capital positions give greater scope for risk taking, and, with last year’s cross-market rise in volatility, higher risk seeking translates to better profits, widening the US-Europe divide even more. It’s little wonder that the S&P 500’s financial sector rose 20% in 2016, whilst STOXX’s European bank index slipped 7%, even after turning higher between July and year-end.

As in infrastructure, for American banks, the risk that financial regulation (finreg) policies—whether offered on Tuesday 28th or later—may disappoint is likelier to bring the downside into view than the upside. It’s notable that Wells Fargo, BofA and JPM generated enough profit to beat estimates in the fourth quarter, but not enough to justify their stock price rises since the U.S. election. At BofA, despite solid gains in most businesses and progress on cutting costs, Return on Equity (ROE) was 7%. Even adding 1% from possible rate increases in 2017 would leave returns under 10%. That is the rate widely regarded as the lowest big banks can get away with whilst retaining the ability to grow profits.

At JPM, annualised ROE was 11%—though only with help from a $475m tax benefit, a $272m gain on credit adjustments, and booking provisions for potential compensation payments of just 20% of revenue, vs. 26% in the year before. Had JPM not deployed such manoeuvres, its ROE would have been 9.3%.

For Wells Fargo, its $5.3bn net income was lower than in the fourth quarter of 2015 and its annualized return of 10.96% dipped below the 11% floor management set as an annual target last spring.

Diminishing returns may not matter much for shares of the biggest U.S. banks, at least for a while, if Trump does indeed deliver a grand package that rolls back Dodd-Frank. But if finreg cuts turn out to be shallower than expected, bank share price falls could be deeper.