Markets "bought" the election. Now the question is whether they will sell the inauguration. That is the take from the latest weekly letter by Goldman's chief strategist David Kostin, who says that "investor angst is high." Kostin then explains the one-word reason behind such confusion and angst - take a wild guess what it is. Which is ironic, because while on one hand investors and strategist are losing sleep over Trump policy uncertainty, on the other hand, every single one of them is convinced that Trump will unleash massive stimulatory tax cuts and hundreds of billions in fiscal stimulus with effectively no risk.
Go figure.
FInally, the Goldman strategist reveals what Goldman believes is the best investing strategy for a Trump presidency (which means most investors may want to do the opposite).
Here is the full note:
Conversations we are having with clients: An investing strategy for a Trump Presidency
"I, Donald John Trump, do solemnly swear that I will faithfully execute the office of President of the United States, and will to the best of my ability, preserve, protect, and defend the Constitution of the United States.” With those words, the New York businessman became at noon today President of the United States of America, completing one of the most improbable election campaigns in the country’s 240-year history.
“Unsettled” is our best description of fund managers’ mindset as the new administration takes office. During an extensive series of client meetings in the US, Europe and Asia, it became apparent that investors are confused about how to best position portfolios under a Trump presidency.
Optimism is reflected in the strong performance of markets during the 73-day transition period between the election and inauguration. Investors have embraced the prospect of faster GDP growth and higher inflation as a result of reduced corporate taxes, a looser fiscal policy, and less regulation. Surveys such as NFIB small business confidence and consumer confidence both soared to their highest levels in 12 and 15 years.
S&P 500 index has climbed by 6% since November 8 led by Cyclicals broadly and Financials in particular. Europe, Japan and MSCI Asia stocks have returned 8%, 12% and 1%, respectively. Implied inflation during the next decade equals 2.0% and the 10-year Treasury now yields 2.47%.
Policy uncertainty was a topic of concern raised in every client meeting. While we expect corporate tax reform legislation will be enacted in 2017, the magnitude of cuts and offsetting revenue proposals are unknown. Many tax reform ideas have been discussed in general terms but the administration has not yet endorsed any specific proposals. Investor confusion increases when a topic that appears to be gaining political momentum – such as border-adjusted tax reform – is suddenly discredited when the President dismisses the idea saying it is “too complicated.”
That, i.e. Trump, in a nutshell, is why everyone is confused. As to how Goldman believes its clients should trade this uncertainty, it updates its analysis of "Rule of 10" stocks (ironically first introduced in a Goldman reportrevealing "secular growth stocks for a secular stagnation economy" which makes one wonder if there is any difference between growth and stagnation) and highlight 31 names that have a demonstrated track record of superior sales growth, are expected to continue growing at a rapid pace in the future, and also trade at a EV/sales multiple below 7.5x which is a key valuation threshold. To wit:
One investment strategy that avoids the risk of potential policy pitfalls is to focus on stocks with high secular growth potential. Last year, we introduced our “Rule of Ten” framework for identifying stocks capable of growing sales rapidly, independent of economic and policy uncertainty. Stocks meeting our “Rule of Ten” have a demonstrated track record of superior sales growth and are expected to continue growing at a rapid pace in the future, while high expected long-term growth suggests that companies operate in a large total addressable market (TAM) .
Our “Rule of Ten” classifies companies as secular growers if they meet three criteria: (1) increased sales by at least 10% in each of the last two years; (2) forecast to grow sales by 10% or more in each of the next two years based on estimates from Goldman Sachs equity research analysts; and (3) have consensus long-term earnings growth of at least 10%.
Only 72 companies out of a US coverage universe of more than 750 stocks meet our secular growth criteria (see Exhibit 1). From a sector perspective, Information Technology (53%), Health Care (23%), and Consumer Discretionary (12%) collectively account for 87% of the firms (see Exhibit 2). In terms of size, 20 stocks are large-caps (greater than $10 billion), 32 are mid-cap ($2 to $10 billion), and 20 are small-cap (less than $2 billion).
Unsurprisingly, most secular growth stocks trade at above-average valuations. Only 10 of our 72 secular growth stocks trade at EV/sales ratios below 2.5x while 21 stocks trade at EV/sales multiples greater than 7.5x. For context, the median S&P 500 firm trades at 2.7x, a record high EV/sales ratio. We recommend investors focus on secular growth at a reasonable price (“secular GARP”). Our previous research showed that applying a valuation filter to our secular growth screen produced higher relative returns. Firms that traded below 7.5x EV/sales tended to outperform by a larger margin, and at a higher hit rate, than firms trading above 7.5x.
Exhibit 5 contains 31 large-cap and mid-cap stocks in the Goldman Sachs US equity research coverage universe that meet our “Rule of Ten” secular growth criteria and trade at EV/sales multiples below 7.5x. We excluded stocks below $2 billion in market cap due to low liquidity as well as firms rated Sell by Goldman Sachs equity research analysts.
The median firm on our list of reasonably priced secular growth stocks delivered sales growth of 27% in 2015 and 26% in 2016, compared with 1% and 2% for the typical S&P 500 firm. Looking forward, the secular growth stocks on our list are forecast to increase sales by 21% this year and by 18% in 2018 compared with 4% growth in both years for the median constituent in the S&P 500. Finally, the long-term EPS growth forecast for the median stock on our list equals 23% compared with 9% for the typical S&P 500 firm. Large-cap secular growth stocks that still trade at reasonable valuations and have double-digit upside to analyst target prices include Twitter (TWTR, +31%), salesforce.com (CRM, 27%), Amazon (AMZN, +24%) and PayPal (PYPL, 19%). Mid-caps include Pandora Media (P, +36%), Envision Healthcare (EVHC, +33%), and INC Research Holdings (INCR, +27%).
And since Goldman's flow traders - currently long this universe of stocks - will be selling all these names to clients, individual investors who are eager to do with Goldman does, not what it says, especially now that Goldman Sachs is officially advising Donald Trump on fiscal policy the same way it used to advise the Fed on monetary policy for years, may consider doing the same.