Burt White, chief investment officer for LPL Financial, checks in on some "so-called Trump trades" – like small caps, financials and industrials – in his weekly market commentary this week.
Recently, these trades have given back some of their pre-election gains.
"Small caps, financials and industrials are each very sensitive to Washington's policies, so how much the Trump administration can get done will go a long way toward determining if these investments perform well over the balance of the year," White writes. "Recent underperformance of each of these areas likely reflects some loss of confidence in the Trump agenda."
While policy is not the only factor to consider when evaluating these investments, it is a "very important one," White says.
White examines the recent weakness in small caps, financials and industrials stocks – and how they each fair under the Trump agenda.
Small Caps
Small-cap stocks may be the most sensitive to the Trump policy agenda, according to White.
"Smaller companies would generally benefit more from a lower corporate tax rate than their larger-cap counterparts because of their greater proportion of domestic revenue and resulting higher tax rates (global multinationals earn more profits overseas in low tax countries)," White says.
According to White, the median corporate tax rate for the companies in the small-cap Russell 2000 is 4% to 5% higher than that of the large-cap S&P 500.
Many smaller, U.S.-focused companies also stand to benefit from the Trump administration's efforts to bring overseas production back to the states. Small caps also generally benefit more from financial deregulation because they tend to be more credit sensitive than large caps and rely more on bank loans than larger companies that tend to have stronger balance sheets.
"Small caps have underperformed in recent months, begging the question of whether the relative weakness reflects dampened enthusiasm for the Trump agenda (our sense is it does), and whether the weakness presents a buying opportunity," White writes.
According to White, the latest dip in small caps is more likely to present a potential opportunity than the start of a period of prolonged weakness, largely because he continues to believe corporate tax reform will pass. Though, he says, corporate tax reform will likely be scaled down from earlier proposals from Trump and congressional Republicans and it may not get done until early 2018.
In addition to the potential boost of corporate tax reform, White notes the improving underlying health of the economy and credit markets.
Financials
White considers the financials sector in the Trump trade category for two reasons.
"First, the Trump agenda has been viewed as likely to put upward pressure on interest rates and steepen the yield curve," he writes, adding, "Second, Trump is a big proponent of financial deregulation and has already taken steps to ease the regulatory burden on financial institutions through executive orders."
