I'm going to be traveling for a couple weeks so no full updates until mid December. I have been working on the impact of a reduced Corporate Tax rate on valuation. It seems likely that Trump and the Republicans will get this done and, in my work, if the rate is reduced to 20%, valuation is made more attractive by 7% to 16%. I think that is one of the things going on in the market currently. I have reduced my hedges so I am now only 50% hedged.
As far as other parts of Trump's agenda, I think it is too early to speculate on what will get done but most of his agenda looks positive for the economy. There are still many questions to be answered, though.
The last two weeks have been spectacular - especially for smaller companies like the ones I tend to own. However, all good things must come to an end and I think we are near that point. Because of this advance, my valuation indicator has declined to a negative level again. The indicator is tied to expected inflation and that data point has increased, even before the election. Combined with a sharply higher bond yield, the outlook has deteriorated enough for me to go back to a fully hedged position. Earnings are still OK and unemployment is stable but sentiment factors have also become much more problematic. Everyone seems very optimistic about Trump's economic agenda but there is a lot of work to be done and much opposition that will have to be overcome.
It was a very timely call when I removed my hedges last week. Small stocks exploded to the upside after the election. Unfortunately, I was not in a big hurry to remove those hedges because of the election uncertainty and I didn't get it done until mid week. Once again I need to learn the lesson of not trying to outguess the market on a day to day basis and simply executing trades on Monday morning. This week, in spite of the big move, I am holding steady and not placing hedges back on. Valuation obviously got worse last week but not sufficiently to turn negative. Earnings expectations are still increasing and unemployment is positive. Some sentiment indicators weakened significantly last week but, overall, sentiment is now neutral. I am showing a two year simulation chart above that is not hedged. My data provider is not giving me what I need to show a hedged result at this time.
There is a certain uneasiness in the air, no doubt having to do with the upcoming election. I would guess that, no matter who wins, there will be serious economic challenges going forward. However, as I mentioned last week, my indicators have improved enough to remove my hedges on the market. I probably will not be in a big hurry to do that given the likely volatility next week but earnings expectations are still positive, valuation has improved and the unemployment rate seems stable. I have moved back to a portfolio of 20 stocks in order to keep things simple and I will be using ETFs to invest excess money that I keep for hedging purposes. I'm looking forward to the election results, mainly because the torture will end.
Richard Moore, CFA
With my wife in Hawaii