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Vermilion Compass: Weekly Equity Strategy

We all know the market hates surprises and uncertainty. “Surprise, surprise, surprise” (as if Gomer Pyle were talking). The market seemed certain Hillary was going to win the election, but “golly,” Trump won, and won convincingly. Equity futures did their own version of “shock” and “awe” the following days, with Brexit action obviously in the minds of futures traders. It turns out, almost everybody's predictions were wrong, and the market rejoiced once more rational/logical minds prevailed. So, we are left to pick up the pieces, and plenty pieces there are.

We have several observations and thoughts:

• Once clearer heads prevailed after election eve there was massive short covering. The shorts were caught off-guard and on the wrong side in a major way.
• Not only did short-covering play a major role in the market's updraft, but sector rotation has commenced, largely toward the cyclical/economic-sensitive sectors, which would typically be the beneficiaries of potential success Trump has in stoking economic growth with this policies.
• The short covering and sector rotations have resulted in spikes upward that historically are a technician's worst nightmare. Are they sustainable? Probably not. But, they denote something huge is afoot, and they are not likely to back and fill in typical fashion. In other words, conventional thinking may not be appropriate given the magnitude of the election surprise (and Republican control of Congress) and the things he is talking about doing (pro economic growth).
• While it's still early to try and forecast Trump's agenda and priorities, we like what we are hearing thus far: tax cuts for individuals and corporations; increased spending on infrastructure adding jobs; tax cuts resulting in repatriation of earnings/dollars held overseas; rollback of growth-hindering regulations for the Financial and Health Care Sectors, etc.
• Interest rates are on the rise across the globe. The speed and magnitude is a concern, but policies Trump is likely to pursue will take time to create, pass into legislation, and implement. It is surely encouraging, however, that Wall Street strategists/economists have already started raising their earnings forecasts for the S&P in the wake of the Trump victory. This economy surely could use some heat.

Recommendations:

1. We are upgrading our weighting in the Transportation Sector from Underweight to Market weight.
2. We are upgrading our weighting in the Consumer Discretionary Sector from Underweight to Market Weight.
3. We are keeping a close watch on the Energy Sector, as it has been acting poorly even as the other cyclical sectors have accelerated their outperformance. Economic growth should stoke demand for energy supplies.
4. Regarding the Health Care Sector, Trump has vowed to fix the ACA, and he is unlikely to pursue legislation to cap pharma/biotech prices. Health Care has long been under siege and is poised for at least a relief rally.
5. The Technology Sector, which has been a leader for a multitude of reasons, is suffering short term from the potential for immigration changes (which would affect the potential talent pool), and the ramifications of possible repatriation of dollars held overseas. We believe the dust will settle soon in this Sector and are maintaining our overweight recommendation.
6. Small-cap stocks will likely outperform the large caps, as they are more leveraged to the economy.
7. The market is adjusting to the “surprise” victory of Trump. Volatility within individual Sectors and stocks will likely remain high through the end of the year.

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