Buy, Buy, Buy
Last week was the biggest rally for stocks since 2014. Treasury yields have launched through 3%. The U.S. dollar is very strong. Yes, investors were taken by surprise last week, when Donald Trump won the election. What you are seeing in the market is evidence of this. Investors are scrambling to adjust their positions to account for an entirely new set of expectations.
And what exactly are these new expectations? We have to sift through the market action and see which stocks are reacting to get a feel for these new expectations. That's my job, or at least, that's what I'm doing right now. I can tell you at the outset, some of the early signals the market is giving off seem misguided. But others look rock solid.
Let's start with the rock-solid moves...
The most solid move I'm seeing right now is coming from banks. Just look at this move for Bank of America (NYSE: BAC)...
That's $17 to $20 in four days. And the volume bars along the bottom of that chart show the biggest surge in buying pressure the stock has seen since the beginning of 2014. I think it's legit...
For one, Bank of America has been trading at a discount to tangible book value for years. If you don't know, tangible book value is "bricks and mortar" valuation that simply seeks to put a monetary value on the buildings and other assets of a company. Goodwill measures and earnings don't count toward tangible book value. I have recommended Bank of America here in Wealth Daily before, largely due to the fact that it has been the most undervalued bank out there.
I wrote last week that BofA and the other banks were rallying because "the 'break up the banks' duo of Elizabeth Warren and Bernie Sanders have lost influence."
But there's even more to it than that. It has to do with the Dodd-Frank banking regulation law.
Now, this law was passed to prevent banks from engaging in the type of behavior that helped bring about the financial crisis. The law basically says that banks have to have more ready cash on hand (Tier 1 capital) and can't make their business all about trading risky assets, like mortgage-backed securities.
Dodd-Frank has long been a target of Republicans. They don't like it because they believe it restricts a bank's ability to make money. And Republicans generally favor less regulation, and Dodd-Frank adds layers of compliance rules that banks have spent millions to understand and implement.
Now, there's a very interesting proposal concerning Dodd-Frank. Some are suggesting that banks should have a "buyout" option. That is, banks that get their Tier 1 capital above Dodd-Frank requirements should be able to start adding some exposure to more risky assets (i.e. mortgage backed securities) to boost their earnings power.
This is a great idea because it rewards good behavior. If you simply let banks do what they want, they will absolutely put the economy at risk again. They did it in the late 1980s, giving us the S&L crisis, and they did it 20 years later with the housing bubble. So adding a "good behavior buyout" to Dodd-Frank is a reasonable compromise to keeping banks healthy and also letting them leverage their earnings.
I've had a $24 target for BofA. Because at $24, BofA would trade at book value and at about a 25% premium to tangible book value. Both of these valuations seem reasonable. And investors are buying the stock as fast as they can right now because not only are these valuations reasonable, but they are also realistic in the near future.
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Another Solid Move
I also think the rally for biotech and pharmaceuticals is legit. Yeah, Clinton had targeted drug prices in her campaign. Trump seems unlikely to go after any companies. So biotech drug prices are probably OK.
Biotechs have been sold steadily for six months. They are the very epitome of beaten down. So much so that they had already started to rally before the election. I think biotechs will continue to make up ground. And there's another catalyst that's not getting much play: a cash repatriation tax holiday. Here's the logic...
Trump is a businessman. Not a very good one, but that's beside the point. The single best way he can get his administration off on a good foot is to get corporate America behind him. He can easily do this by simply offering U.S. companies the one-time opportunity to bring foreign cash home and pay a low tax rate, like 10%. And pharmaceuticals like Merck (NYSE: MRK) and Pfizer (NYSE: PFE) have a lot of money overseas.
Let them bring it back, and they are likely to put it to work — with acquisitions in the biotech space.
The BS Moves
I'm gonna start this section with a question. What other group of companies has a lot of cash overseas?
Yeah, tech companies. And big tech companies have been creamed over the last few days. Facebook, Amazon, Apple — they are all off between 7% and 10%. Near as I can tell, investors are worried that Trump's immigration actions might keep these companies from attracting talent from overseas, and so their businesses might suffer.
That just doesn't seem reasonable. Apple is the biggest company in the world. It's simply not going to get steamrolled by policy. And Apple could have a lot of cash to put to work if there is a tax holiday on overseas cash.
So, I think the big sell-off for tech stocks is overdone. Buying them now for a trade is probably a very good idea.
One More BS Move
I do think Trump will get an infrastructure bill passed. Republicans have resisted increases in spending under Obama. But that's because they don't like him and they haven't wanted to help him succeed (regardless of what's good for the country). But now that there's a Republican in charge, you can bet they will open the purse strings.
Still, even with a big infrastructure spending bill, should shares of Caterpillar be trading near two-year highs? The forward P/E for CAT is now 29. And revenue is still expected to be flat from this year to next. Flat, as in no growth. Seems to me that CAT might sell a few more pieces of heavy machinery under a spending bill. But I don't see how they sell enough to justify a forward P/E of 29. Aren't there a bunch CAT machines sitting around idle right now?
I'm looking at buying some puts on CAT at the first sign of weakness.
Until next time,
A 21-year veteran of the newsletter business, Briton Ryle is the editor of The Wealth Advisory income stock newsletter, with a focus on top-quality dividend growth stocks and REITs. Briton also manages the Real Income Trader advisory service, where his readers take regular cash payouts using a low-risk covered call option strategy. He also contributes a weekly column to the Wealth Daily e-letter. To learn more about Briton, click here.
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