Investors have seen a dramatic and, for many, surprising rise in the U.S. stock market since Donald TrumpDonald TrumpMedia giants side with Bannon on request to release Jan. 6 documents Cheney warns of consequences for Trump in dealings with Jan. 6 committee Jan. 6 panel recommends contempt charges for Trump DOJ official MORE was elected president. Those who looked at his economic policy instead of listening to political rhetoric saw this coming. To make accurate predictions on stocks after Inauguration Day, you have to look at what has already happened, which is a dramatic rise in stocks, the dollar and bond yields.
If you combine this with what Trump has pledged to do, along with rationalizing what he may actually be able to accomplish, you can develop a good forecast after Jan. 20.
Based on current earnings, the rising dollar and interest rates, the U.S. stock market is appears 10 percent overvalued, but not based on projected earnings. Because of Trump’s likely economic policy, corporate earnings will rise substantially, and bond yields should rise, the net of which should result in no meaningful increase in stocks in the near term. Here are the most important policy elements as they affect stocks.
The repatriation of corporate profits will cause an increase in the anemic mergers and acquisitions activity of recent years. This will be a boon for banks and small to midsize companies, which will benefit from increased valuations, especially in the technology sector, where much of the mergers and acquisitions activity will focus. It will also cause more stock buybacks, which will mildly support prices.
The planned tax cuts are criticized by the left as another break for the wealthy, but the true beneficiaries will be the middle class, working poor and small businesses. Benefits to the wealthy will be offset by the closing of many loopholes they currently use to lower their effective rates. Reductions to those in lower tax brackets and small businesses are significant and will act as a large fiscal stimulus.
In normal recoveries into their eighth year, fiscal stimulus would be unnecessary. But the current recovery is the slowest since 1949 and therefore could use a good kick start. This stimulus should do the trick, and I expect gross domestic product (GDP) growth to rise above 3 percent on a sustainable basis for the first time since the middle of George W. Bush’s presidency. This will cause inflation to rise to 2 percent to 2.5 percent and 10-year bond yields to jump to 3 percent. The stimulus result is more money in the pockets of those who will spend it, a promise President Obama made but did not keep.
Lower corporate tax rates make the United States more competitive. Our current rate of 35 percent is the highest in the world. I expect the rate to change to 20 percent (Trump has proposed a 15 percent rate). This will incentivize companies to bring jobs back to the United States. Lower taxes will boost corporate earnings and serve as additional fiscal stimulus by increasing demand for U.S. workers, thus raising their wages.
Deregulation will have an impact on banks and small businesses. If the Dodd-Frank Act is weakened, banks’ earnings will increase due to less constraint on their business activity. Cutting back bank regulation could be quite dangerous, but it will be a positive for bank earnings. Small businesses, and thus the middle class, should benefit if current onerous regulations are reduced.
Trump’s plan to increase infrastructure spending is long overdue and will provide additional fiscal stimulus. AECOM (ACM) and Chicago Bridge & Iron (CBI) are companies that will benefit. They have already soared 18 percent and 30 percent, respectively, since before the election, and they have more room to run.
Trump also plans to retool our military, which will make Lockheed Martin (LMT), Northrop Grumman (NOC) and General Dynamics (GD) direct beneficiaries. They again rose dramatically after the election, but I caution that pricing will be an issue in future defense contracts. These stocks are not as sure a bet as infrastructure plays.
Trump promises to repeal ObamaCare, but with little stated as to what will replace it. The reality is that socialized medical care is not the problem. The cost of medical care in the United States is the real issue. When the new administration and Congress attempt to develop a new plan, they will quickly realize none will provide adequate medical coverage for Americans at a reasonable price unless there is dramatic reductions in health care costs. The attention will move to cost reduction. Given the power of healthcare lobbyists, reform will be an enormous undertaking. But no doubt a giant industry spotlight will remain on healthcare for many years, and I recommend a significant underweight in this industry.
My stock picks for 2017 fall into the theme of stronger American consumers, due to expansive fiscal policy, and finally some meaningful real wage gains. Investors should buy homebuilders, as demand for housing increases; banks, given the weakening of Dodd-Frank, and JPMorgan Chase (JPM) the best of the breed; U.S. automakers, with General Motors (GM) in particular extremely cheap; infrastructure companies, including AECOM (ACM) and Chicago Bridge & Iron (CBI) as good infrastructure plays; U.S. airlines, with United Airlines (UAL) in particular still cheap. Steer clear from healthcare stocks as our government attempts to tackle the mess in this industry.
I predict the S&P 500 will end the year where it started—around 2,250 points. S&P 500 earnings will rise to $120 even with a strong dollar, powered by the strengthening U.S. consumer and lower corporate taxes. This will be tempered by a further rise in yields and inflation, lowering the index’s price-to-earnings multiple. Although the year may end flat, taking these investment suggestions can make 2017 a profitable year.
Michael Palumbo is the founder of Third Millennium Trading and the author of “Calculated Risk: The Modern Entrepreneur’s Handbook.”
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