Trump trade unrelenting as market maintains momentum

Current Overview

The Trump trade (or close cousin Reflation Trade depending
on one’s preference) continues apace. The Dow Jones has appreciated a further
5% since my report last month as investors continue to buy into the positive
economic potential effects of tax cuts, massive infrastructure and defence spending
and deregulation, all of which the Trump administration has promised.  Indices are again at all-time highs.  On a “yield gap” basis which compares equity
(shares) yields with bond yields,  shares
still represent good value ; at least according to the market bulls.  Versus interest (savings account) rates there
also remains appeal although rates are on the rise, if only in the US
currently.  Assisting the mood in the
markets is a significantly reduced anxiety relating to the Chinese economy.
While some (still) consider China to be a contrarian (unloved) region, confidence
has again risen for a projected and stable growth rate of around 6.5%.  For now interest rate cuts and surprise currency
devaluations seem off the agenda.  The
Chinese influence on markets should not be underestimated.   

While expectations for further interest rate rises in the US
are well documented, interestingly bond (Treasury) yields actually suggest
certain investors remain somewhat unconvinced in the Trump induced euphoric
outlook as evidenced in equity pricing. 
Policy detail remains elusive even if the President’s recent address to
Congress was much more statesman like. Clarification of policy could bring risk
back into markets especially in the area of international trade where an
isolationist approach is worrying to many. 
Moreover the ascent in the value of the dollar could also soon represent
a significant challenge for the American economy as US exports become
increasingly expensive versus imports that look cheaper. Companies that export
to America may ironically look like winners in a complete challenge to Trump’s
ambitions to protect America across the board.

Turning to the UK, the FTSE 100 has appreciated 3% further
on the month also residing near a record high. Transatlantic read-across has
been obvious but more importantly the weakness in sterling continues to boost
blue chips with dollar earnings; pharmaceutical companies for example are once
again trading strongly. To remind readers, the FTSE 100 is comprised of
companies, most of which have high overseas earnings capabilities. The weak
pound means profits are being boosted (flattered even) by current exchange rates;
it does not necessarily mean genuine organic profit growth is evident if
currency fluctuations are stripped out. 
This factor poses a risk to the market.

UK economists continue to ponder when the BOE will raise
rates and views remain varied. Where some feel GDP is strong enough to absorb a
base rate increase, others believe (pre Brexit) any tightening would be crazy
and premature.  Low rates facilitate a
weaker pound which benefits exporters but brings headaches to importers of
goods such as retailers. What would be improved news for some sectors, would be
bad news for others. But this has always been the case. My personal view is
that we may see a rise later in the year but there is much economic and
political newsflow due in the interim that will shape monetary policy.  

A final point in terms of understanding some of the strength
we have been experiencing in the UK stock market may be linked to the perceived
safer haven status of London listed companies in the context of an increasingly
risky Eurozone.  It is also important not
to forget that UK listed plc remains effectively on sale as a result of the
weak pound.  Further takeover activity
should be expected and M & A is always a positive for those seeking capital
growth opportunity.

Market specific comment

Babcock International (908p) has grabbed my interest. A
robust trading statement last week gave rise to a material rally in the share
price as apprehensions relating to its support services categorisation
eased.  A price to earnings ratio of 11
for 2017 rates attractive with the stock sitting near 3 year lows where the chart
indicates support.  Going forward 7-8%
earnings growth is forecasted and I am particularly interested in their fastest
growing section of business which is defence and cyber security.  A progressive, well covered (secure) 3% income
yield brings additional total return potential to the investment case. Core
areas of capability are in marine, land, aviation and nuclear engineering
markets supplemented by expertise in technology, training and infrastructure.
Cash generation and conversion is strong and a priority, comfortably financing
net debt balance sheet obligations.  International
expansion is also evident and outsourcing is gaining traction outside of the
UK.  Unjustifiably depressed by other
sector names such as Capita and Serco in support services, I have an initial
target level of 1000p over the next 6 months.

Standard Life and Aberdeen Asset Management have announced
intentions to merge. While deals such as these bring natural interest, I
suspect this deal is the bringing together of two weakening and challenged
companies.  As a holder of Aberdeen stock
on behalf of clients, a premium cash takeover would have been the preferred
option.  Rather than face a dividend
reduction, Aberdeen has seemingly opted for the least worst option of jumping
into bed with a Scottish rival.  Medium
term benefits will likely emerge from synergies alongside cost cutting plans
and the merged group will become a stronger and leaner asset management
business in time.  Expect to see further
consolidation in this space going forward.

To conclude, I am pleased to report upside progress in both
National Grid (up 7% to 977p) and Vodafone (up 5.7% to 203p) which I
highlighted last month as capital growth options with high yield attractions. I
continue to hold onto both for further share price improvement.

This report was written by Philip Scott, Director at SI
Capital on 7/3/17 when the FTSE 100 was trading at 7350.