The Brave New Reality Show

Wednesday, April 19th, 2017

An entity previously known as THE DONALD is now President Trump, causing fear and trembling in many circles and jubilation in others.  There will likely be some pullback on both viewpoints in the next few years but it is worth noting that sales of George Orwell’s classic 1984 have skyrocketed.  On the investment sentiment front there appears to be some consensus based on the post-election stock market upswing, that the domestic economy could grow faster than in the previous 8 years with less regulation and lower taxes.  However, the unpredictable President’s relationship with a Republican controlled Congress is a shotgun marriage at best, which went badly awry over the attempted repeal of Obama’s Affordable Care Act.  There is a lot of blame to go around but Trump’s disdain for a Republican controlled Congress reveals that unless he changes course we will likely see future legislative debacles.  Since Trump likes to boast that he doesn’t read much but watches a lot of TV, perhaps the new President should stream, ALL THE WAY, the excellent 2016 HBO movie about LBJ, and he could learn how an accidental President went about getting what he needed from Congress. For starters you never call for a vote you unless you know the result, and you can find some pretty unorthodox and unseemly ways to get the votes you need.  Trump would see how LBJ orchestrated the passage of the landmark 1964 Civil Rights Bill over a filibuster led by his close friend and former Dixiecrat ally Senator Richard Russell.  One way LBJ circumvented Russell’s filibuster was to go to the Republicans, which seemed more than a long shot at the time. But LBJ knew if he got minority leader Evert Dirksen on his side the others would follow. Fortunately he understood what button to push with the Republican minority leader and told Senator Humphrey the bill’s floor manager exactly what to do—“Hubert, kiss Dirksen’s ass so hard that he can’t sit down.” It worked:  they convinced Dirksen, the Illinois Republican that he carried Abraham Lincoln’s mantle and would cement his legacy by backing the Civil Rights Bill.  LBJ, an outsider like Trump—a role he milked expertly, always complained that the eastern establishment liberals hated him. But he made sure to keep JFK’s cabinet intact, and as he succinctly put it: “Better to have them on the inside of my tent pissing out.” Since everything is negotiable for the former real estate developer, and he’s boasted about getting some sticky deals done, he might want to take that cue from LBJ since there is another attempt at repealing the Affordable Care Act in the works with trade and tax reform bills to follow.  Perhaps VP Mike Pence and House Speaker Paul Ryan should join the viewing party.

So far the stock market generally likes what it wants to perceive from the new administration. The bullish consensus is that there is enough agreement by the concerned parties on several “business friendly “issues to promote a growth agenda. The less sanguine view voiced by economists such as Lawrence Summers, the former head of President Bill Clinton’s Office of Economic Advisors, is that the Trump team is promoting “Voodoo Economics,” and that tax policies repatriating offshore cash coupled with protectionist tariffs will not lead to increased capital investment or produce growth.  The two executive orders issued during Trump’s first week on the job might be an indication of what could ensue:  he reversed President Obama’s halt of two contested pipeline projects: Keystone, which when built will transport Canadian oil to Texas refineries and Bakken, a domestic pipeline approved and 95% completed until protesters convinced President Obama that it came too close to the Standing Rock reservation. Republican lawmakers as well as several Democrats applauded President Trump’s move, but not surprisingly he then threw a wrench into the mix by insisting that the companies involved, TransCanada and Energy Transfer use only US manufactured materials to build their pipelines.  Energy Transfer has said that’s what they intended to do and there has been some hedging by TransCanada on the Keystone supply chain. There was the expected objection to Trumps executive orders from environmental and tribal groups who had successfully lobbied President Obama.  But then unlikely allies such as the Cato Institute, a libertarian think tank funded by the Koch brothers, joined in.  The director of the conservative institute’s trade policy center vociferously objected to the President telling private companies where they have to buy their materials, describing it as “without legal authority, dictatorial and a very bad precedent.”   There is also the stunning irony of the real estate mogul turned President issuing the order since his landmark buildings were constructed with cheap non-US steel.

The investment markets quickly grow nervous with perceived chaos and the current occupant of the White House so far has done little to alleviate that concern.  The one orderly component that matters much more to investors than who sits in the Oval Office or what is tweeted in the wee hours is the activity of the Federal Reserve.  As was the case during the past administration, the Fed and its decisions on interest rates and open market bond purchases created the positive macro economic conditions for the financial markets. The reactions to Trump’s unorthodox presidency will likely continue and even escalate, and despite the assumption of a more business friendly environment, there is really no compelling reason to call the post-election stock market upswing a “Trump Rally.”  The more correct moniker remains a Bernanke/ Yellen rally.  During the first quarter of 2017, the Dow Jones Industrials gained 4.5% and the S&P 500 gained 5.5%.  Since the Dow Industrials contains more energy companies than the S&P, the downturn in oil prices explains the Dow lagging the S&P.  Balanced indices with a component of fixed income gained 3.5% reflecting a pullback in bonds.  Dividend and covered call Exchange Traded Funds fared better gaining between 4 and 5%.  Since the Federal Reserve has announced that there will be at least two more interest rate hikes to the Federal Funds rate in 2017and that many of the bonds on their balance sheet will be bought back, the case for dividend funds and conservative option income strategies in a gradual rising interest rate environment appears to be strong.  Most of the companies in the S&P are raising dividends and the yields on their stock are higher their own high-grade bonds. For example Johnson and Johnson common stock currently yields 2.6% while their most recent issue of AAA 5-year bonds came to market with a yield of 1.7%, roughly comparable to a 5-year Treasury. JNJ has raised its dividend annually for the past 55 years and the current dividend of $ 3.20 reflects a 90% increase since 2007, which was the last time the 5-year Treasury was at 5%.  So while the Fed is raising rates, investors seeking income from their investments will need to look beyond bonds for it will likely be several years before the 5-year Treasury is back at 5%.  Generating cash flow through dividend growth and conservative option strategies make sense in a low interest rate environment.  An article in the March 2017 issue of Institutional Investor notes that public pension funds are divesting from poorly performing hedge funds that charge high fees and are now using covered call and cash secured put selling as a way to protect their equity holdings and reduce volatility at a lower price.  In what will likely be a confusing and volatile global political landscape, a low cost hedged strategy makes sense for investors of all stripes and sizes.

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