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Analyst Interview: What Wedbush Thinks of the Trump Trade

Will everything investors have been hoping for about to become reality?

Make sure you read all of this month’s special feature coverage leading up to President Trump’s First 100 Days here.

As the nation braces for the upcoming inauguration of President-elect Trump, the financial markets have been jostling around in the meanwhile. The “Trump trade” has been the dominant theme for investors over the past two months and now, as the rubber finally meets the road, bulls and bears alike are anxiously anticipating whether their positions are on the right side of the transition between expectations and reality.

Over the course of January, has examined the potential economic effects and implications for investors of Trump’s first 100 days in office, assessing the 45th President’s most likely priorities, potential obstacles, and strategic advantages during what is historically a critical period for a presidency. But we also wanted to provide insight into how investors may want to play this theme going forward.

To do so, spoke to Gil Luria, Managing Director and Head of Equities Research for Wedbush Securities. Luria covers a lot of ground in this interview, discussing a number of sectors that investors have piled into since the election, and provides a few names Wedbush likes as the Trump trade really gets rolling here.

EQ: Since the election, there have been some clear winners and losers among market sectors based on what investors think will do well under the Trump administration. However, many of these sectors do seem to be more susceptible to outside macro forces than just the administration’s incoming policies. Are investors putting too much weight on that factor right now?

Luria: I’d say there’s quite a bit of optimism all around. Investors have taken various sectors and assumed the best for each of those sectors, even when some of those assumptions are not congruent. There are a lot of companies that have benefited, whether from the idea of lower corporate taxes, or companies that have big US businesses, and companies that could repatriate foreign earnings. At the same time, infrastructure companies and industrial companies have benefited as well under the assumption that there is going to be a lot of spending on infrastructure.

But if we’ve learned something from the last few decades from the various types of past administrations, it’s that it’s very hard to both cut taxes and increase spending without causing other problems, such as higher deficits, which leads to higher debt levels, which leads to higher interest payments, creating a situation that’s unsustainable. So, the market is now assuming all the good things are going to happen. I think investors should be more focused on the things they actually believe are going to happen, and stay away from the blanket optimism that has taken over the market over the last couple months.

EQ: One of the big themes is the peel-back regulation, and Financials is among those that look to most benefit from that. Do you think the impact will be as significant as projected?

Luria: That’s another example. It is very likely that the administration is going to try to roll back regulation as a whole. This is an administration that is modeled after the Reagan Presidency. President Reagan did a lot to try to unwind and simplify regulation. There are places where that could be easier to do. For instance, environmental protection. When your adversary is the Sierra Club, and you control the executive branch in the legislative branch and possibly soon the judicial branch, it’s much easier to roll back those types of regulations.

Financial regulations are far more complicated. Some of the counterparts there are not activists or concerned citizens. They’re actually other sectors of the economy. As an example, a big part of the Dodd Frank regulation was the Durbin Amendment, where the Federal Reserve controlled interchange rates for banks. That was not a result of overly regulated banks. That was a result of retailers’ outcry about what they saw as unfair competitive behavior from banks and credit card companies. That’s an example of legislation that is unlikely to get rolled back simply because the constituency of retailers will still be powerful regardless of what the administration is.

So, some easing of regulations for financial institutions and banks should be expected, but a blanket rollback of Dodd Frank and other types of regulations may be an oversimplification.

EQ: The Volcker Rule is one that’s talked about a lot. But repeal would seem to benefit only the largest banks that have both trading and banking operations. Will this have a material impact in the broader financial space?

Luria: I don’t think so. Assuming that it gets rolled back, to your point, the Volcker Rule has more to do with a handful of institutions that have done well and will continue to do well, and the Volcker Rule was not much of a setback for them to begin with and won’t be that much of a benefit if it’s rolled back. But for all other banks and financial institutions, it’s unlikely to have much of an impact altogether.

EQ: In addition to easing of regulation and capital requirements on banks to lend, the rate environment is also rising. How will the combination of these forces benefit banks?

Luria: Those two things are not unrelated. We were heading into a rising rate environment before the possibility of fiscal stimulus, lower tax rates, and higher infrastructure spending. To the extent that we see one or both of those in the upcoming year and get signals for it in the first 100 days of the administration, that appeared to be a factor that could accelerate rate increases. That, at least, is what we’ve heard from Fed Chair Yellen. The signaling of fiscal stimulus could impact the Fed’s decision of potentially an even steeper slope for rate increases, which obviously benefits the banks as a group, and some more than others.

EQ: So, what are some areas specifically within the Financials sector that Wedbush likes?

Luria: The benefit from rising interest rates, independent from regulation, would mean that regional banks such as Regions Financial (RF) would be in a very good position. There are certain mortgage REITS we’ve identified, like New Residential Investment Corp. (NRZ), as one that’s among the most exposed to a rising rate environment. So, we’ve isolated that one as a particularly interesting investment. But obviously, banks as a category should benefit, as the stocks reflect at this point.

EQ: FinTech was, and still is, a very hot space over the past couple of years, but it’s an industry that’s predominantly positioned as an alternative to traditional financial institutions. Now that financial institutions are coming back into favor, how does this affect FinTech going forward?

Luria: There are two types of FinTech companies. There are the ones that are trying to displace financial institutions, and the ones that are trying to serve financial institutions. The ones that are trying to serve financial institutions should benefit greatly from increased spending by banks. As those banks generate more revenue and start growing for the first time in a long time, there will be resources for them to invest in the technology that they’ve been neglecting for so many years. One that we like is Fidelity National Information Services (FIS).

In terms of the group of FinTech companies trying to displace and replace banks, which have been so constrained over the last few years, I don’t necessarily know that I am as optimistic about them. For example, there is LendingClub (LC), which our analysts have an underperform rating on. If banks are growing and lending again, the demand for alternative types of venues to borrow from by companies in need of capital is going to become less pronounced. Therefore, the companies that are trying to replace banks may not be doing as well.

EQ: Looking to the Energy sector, there is a lot of bullish sentiment for this group because of expectation that environmental restrictions will be pulled back. However, on a macro level, it’s also dealing with a lot of headwinds with regards to low energy prices, excess supply and, if you look at coal, things that are just going out of favor. What are your thoughts on the Energy space?

Luria: This is a place where it does appear there is a clear path for less regulation. Again, the resistance is from environmental groups and other elements in the Democratic party, which will have very little input going forward. So it is safe to assume that large energy companies are going to have opportunity to expand their businesses in areas where they previously were limited. To me, those are the safest bets in the Energy sector; large energy providers that have a diversified business where lower prices in one place don’t necessarily mean lower prices everywhere. Therefore they’ll be able to thrive as the restrictions on them are lifted.

So large integrated oil might be the group best positioned, not just because of the new influence they’ll have in the highest offices in the land, but also because of the opening up of new areas for exploration in the US, and reducing restrictions on various aspects of their business. They are going to be in the best position to make the most of that because of their influence and scope.

EQ: With regards to the Health Care sector, the Republican party has made it their top priority to repeal the Affordable Care Act. That much is clear. On the other hand, everything else is very unclear. What do you see here for the near term?

Luria: Well, I would say Health Care is where we actually have the highest level of uncertainty. It’s highly likely that there will be a repeal of some sort, even if it’s just by name. They can’t have it as a goal for the last six years, then finally take charge of the White House, and just let it go. So, the repeal by name is very likely to happen. The uncertainty comes from the fact that it’s unclear what’s going to happen instead after that repeal. One of the scenarios that is being talked about is the 2020 route, in that there will be a celebration of the fact that Obamacare is finally repealed, but the can is going to be kicked down the road another three or four years before there’s a solution.

What that means is that for companies where insurance coverage drives their business–the large payers and providers–are going to be in limbo for an uncertain period of time. Let’s not forget, these companies have been in limbo since Obamacare was legislated. There have been winners and losers, but it has not always been clear who is going to be which, from payers to providers, and the large health insurance providers to the large hospital chains.

So it appears that uncertainty is going to continue, which means that in terms of picking winners in Health Care, we look at places where lower regulation and lower levels of scrutiny can help. So that would be the very innovative biotechnology companies. That’s where we believe the benefits are going to be. If the discussion goes away from limiting drug prices, then innovative biotechnology companies will be in good position. A few names would be Ardelyx, Inc. (ARDX), Lexicon Pharmaceuticals, Inc. (LXRX), and NovoCure Limited (NVCR). These types of very innovative biotechnology companies will be able to properly and appropriately bring their products to the market without having to worry about having their prices regulated.

EQ: Regarding drug pricing, one of the suggested solutions has been to expedite the FDA approval process, which would help to bring development costs down. While this could help companies bring products to market quicker, it could also mean more direct competitors as well. Is this better or worse for these companies?

Luria: It would be more beneficial than not. Patent laws serve as the main line of defense against competition, and that’s unlikely to change. But any increase of the FDA throughput, shortening of FDA processes, lowering of the bars at the FDA – anything like that would benefit these innovative biotechnology companies. It’s also unlikely we’re going to see a more restrictive environment for these drug companies under this administration, because there is a very straight line between the success of innovative biotechnology companies and the creation of wealth and the creation of jobs.

EQ: One of the broader themes here seems to be that traditional sectors are making a comeback in this environment. Under the Obama administration, investor sentiment leaned more toward emerging growth and innovative technology sectors. Do you see this reversing?

Luria: Not at all. There were some programs that were criticized, such as loans to alternative energy companies, but those were few and far between. For every failure, there were enormous success stories like Tesla (TSLA). So, I would say that pulling back on the support of innovation is also highly unlikely in an administration that is focused on creating domestic jobs. It’s much more likely that there will be a more laissez-faire approach to technology companies so that they can thrive and invest and create more jobs and more wealth. So, in that regard, I would say that the opportunity is actually greater going forward for technology companies.

EQ: Creating domestic jobs certainly is the priority under the Trump administration’s economic strategy, and this definitely impacts consumer-oriented stocks. On one hand, more jobs allows for more spending. On the other hand, in order to create those jobs, there are trade issues now being presented that weren’t there before, which could lead to higher prices. What is the net effect on the consumer space?

Luria: I would look to the companies with a lot of domestic consumption, which should benefit more than others as the US has already stood out in comparison to other global economies in its ability to sustain growth, positive consumer sentiment, lower unemployment and higher wages that we’re starting to see flow through. So I would offer Brunswick Corporation (BC), which should do very well. When people generate wealth and have the resources available, buying a boat is often a good outlet for them to celebrate their success.

Companies that have a large mix of consumption in countries such as China and Mexico would probably be the ones that would have the greater risk. That’s where I would draw the line. Companies that look to have more domestic consumption should stand out as beneficiaries, and companies that sell more in countries that could end up being limited in the trade flow are the ones that are likely to suffer more.

EQ: With that in mind, small-cap stocks tend to have much less international exposure, and have benefited from that since the election. Would this be a space you’re optimistic about?

Luria: Absolutely. Domestic small caps tend to be in that category. They’ll benefit from less regulations and a revived consumer. They don’t have to worry as much about consumption outside the United States. They’re in the sweet spot of these uptrends.

EQ: Lastly, you’ve talked a lot about bitcoin, so I wanted to get your thoughts on some of the more popular alternative investments, such as gold and bitcoin. What are your thoughts on allocating some capital outside of equities?

Luria: I would put bitcoin and gold in two very different categories. Gold has, for a long time, been a kind of safe haven in that, not only is it relatively uncorrelated to the movements of equities and fixed income and real estate, it also has a sense of tangible value and longevity. For investors seeking to put part of their portfolio in a safe haven, it serves as an outlet for that type of investing agenda.

Bitcoin is on the other extreme. Bitcoin is a very promising new technology that has tremendous potential but also is a binary bet. It can either be successful and worth many multiples of what it is trading at now, or it could be displaced by a different cryptocurrency that serves these purposes and applications better. So it’s not a safe haven by any stretch of the imagination. The commonality with gold is that it’s uncorrelated. Bitcoin’s success is entirely uncorrelated with the movements of the capital market. It is uncorrelated with how stocks, real estate and bonds tend to move together. It is a completely separate asset class, accessible through separate trading venues, and it’s quite liquid. It has a lot of upsides to the extent that the technology is successful but there is very little in downside protection to the extent that it’s displaced by a new, better technology.

EQ: In March of last year, Ian Winer, Wedbush’s director of equity sales trading, said the market could fall by 50% over the course of Trump’s presidency. That certainly got investors’ attention. Where do you think we stand now?

Luria: I think at that point in time, there was a lot of fear of upheaval if President-Elect Trump was elected. What we’ve gone through over the last couple of months is a realization of the agenda that he brings to the table and that the Republican party that’s now in control of the different branches of government brings to the table. There’s a lot more focus on the positive aspects that it could bring. So I think at the time, that was a very valid and easy-to-justify perspective. But with the context that we have almost a year later, it appears that there are a lot more positive outcomes that are possible.

Keep coming back for the rest of this month as we continue to explore what, exactly, is in store for markets under the new Trump administration. Be sure to read:

AT&T, T-Mobile and Verizon should be turning the volume up. Their current quiet murmur is just not enough.