Investors Love These ‘Trump Bump’ Sectors, But Should They?

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

With the inauguration of Donald Trump fast approaching, and the new Congress already in session, we’re continuing our look into what investors should expect from the incoming Trump administration. After delving into what broad themes and skeletal plans can be gleaned from the Trump campaign and his cabinet selections thus far, it’s time to dig into a more industry-specific approach.

And in this sense, much of what has been laid out to this point is positive. Trump’s outlook has been decidedly pro-business for the most part. Sure, there’s potential for a lot of chaos in certain industries if he gets a chance to implement certain policies (something we’ll touch on later this week), but the bulk of the sector-specific outlook so far appears to be expectations of growth, particularly in sectors where Trump has been active in condemning regulation. What’s more, the industries where Trump is offering his most explicit pledges of support tend to be those that viewed the Obama administration, fairly or not, as a mortal enemy.

With a new era of government dawning, the early returns have been roundly positive for the Energy and Financial sectors, pointing towards expectations of solid growth in corporate earnings there. But can the reality meet these expectations? Only time will tell, and there are plenty of considerations that are well beyond the scope of the incoming President that may play a big role.

Trump Administration Not Expected to be “Low Energy”

Perhaps no sector got a more specific and persistent endorsement throughout the campaign than energy. Trump’s rhetoric was explicit: he wants to grow the domestic production of fossil fuels as aggressively as possible. What’s more, since then, his intention to appoint former Exxon Mobil (XOM) CEO Rex Tillerson as Secretary of State and Texas Governor Rick Perry as Secretary of Energy would indicate that he has every intention of following through on campaign-trail rhetoric.

All that could mean big things for the Energy sector in the coming years. An easier regulatory environment for frackers should allow them to continue operating with ease, and the opening up of new areas for drilling should benefit those companies that can obtain leases. Companies engaged in offshore drilling may be in for a solid future if a Trump administration is successful in rolling back restrictions there, though the Obama Administration has been doing what it can to block that from happening even after it leaves office. Midstream companies, as well, should anticipate benefits in a new energy economy under Trump. Companies like Energy Transfer Partners (ETP), which is building the Dakota Access Pipeline, and TransCanada (TRP), which is building the Keystone XL Pipeline, can expect a White House that’s supportive of their goals, and may give them the chance to undertake or finish their projects. Even beyond those companies planning on new pipelines, an uptick in production should mean more oil flowing from production centers to refineries and distribution centers, which should benefit midstream players regardless of global oil prices.

Can Trump Defy Global Forces in Energy Sector?

Global oil prices are pretty important to the whole energy tango, as it’s the larger pieces of the macro environment that could ultimately overshadow any shifts in government policy. If oil stays at $40 a barrel, plenty of producers may not expand production regardless of how much easier the Trump administration makes it.

That said, recent global developments could just as easily conspire with the new administration to boost prospects for domestic producers even further. The recent agreement by OPEC to cut production by 1.2 million barrels a day could be extremely fortuitous timing for North American oil and gas companies. If OPEC cuts and an expected end to the supply glut drives up oil prices at the same time that American producers are seeing their supplies spike, it could mean windfall profits. But there’s plenty of uncertainty as well. A jump in production in America could essentially counter-balance the OPEC cuts, particularly if the OPEC deal sees members fail to comply with the agreement.

Ultimately, oil prices are volatile and difficult to predict, something that the fortunes made and lost on oil futures year after year should make clear. And, unfortunately for anyone counting on a massive rally for the Energy sector in the new year, they’ll have a lot more to do with the success or failure of oil and gas producers than any changes in government policy could.

That’s something people hoping for a rebound for the coal industry should also keep in mind. Battered by bankruptcies in recent years, the coal industry may have believed it found its champion in Trump, who repeatedly insisted that he would expand coal mining in his new administration by eliminating Obama Administration EPA rules.

Unfortunately for the coal industry, while those EPA rules probably helped put a cap on a potential recovery, the primary culprit in the decline of coal’s place in the economy was cheap natural gas produced by fracking, something Trump only plans to bolster. While the ailing industry may be able to halt its decline, or even show some improvement after a lengthy down cycle, the odds of any sort of significant gains seem low, regardless of Trump’s campaign speech bluster.

Trump’s Economic Plan Sounds Like a Gordon Gekko Fever Dream

The other major sector that appears to be anticipating substantial gains under a Trump administration would be Financials, where the expectation that Dodd Frank will be significantly rolled back, if not repealed, has large banks positively giddy.

It is interesting that Trump has managed to combine his populist message with policy proposals that are so clearly beneficial to the largest Wall Street banks, but there doesn’t appear to be much, if any vocal backlash from his base of supporters, so things should be full speed ahead. His incoming Treasury Secretary, former Goldman Sachs (GS) partner Steven Mnuchin, has already expressed an intent to eliminate the Volcker Rule that banned banks from engaging in proprietary trading with government-insured deposits, calling the rule overly complicated and confusing.

What’s that going to mean? Well, it’s likely to mean the big banks will make significantly more money, at least in the near term. The purpose of Dodd Frank and the Volcker Rule was to ensure systemic stability, so even if removing the rules is a mistake in the long run, it would likely take years before any negative impact is felt, and earnings will likely grow in the meantime. Hedge funds will likely get an influx of cash from the largest banks as they look to boost their trading investments once the shackles are taken off.

Trump Relying on Big Bank Growth Trickling Down to the Rest of Us

So just how widespread will the benefits of rolling back regulations be? That remains anyone’s guess. One argument would be that an easing of regulations will generate widespread growth in lending, boosting overall growth in the process, but that would seem to ignore the reality that most lending is done by the sort of smaller, regional banks that aren’t directly affected by Dodd Frank regulations (though, there may be a legitimate gripe that the $50 billion in assets threshold laid out in the law low enough that it gathers up too many mid-sized banks in its net that shouldn’t be under as much regulation).

Lending has remained depressed since the housing crisis, never recovering to similar levels. That’s likely made things harder for small businesses and depressed growth along the way. In that sense, there’s at least the potential that opening up the largest banks to reinvest in prop trading or reducing capital requirements might create a trickle-down effect that would boost lending across the board and, vis-à-vis, juice growth across the board. Of course, this assumes that those banks won’t just plow any increased earnings into dividends and share buybacks rather than expanding lending, which seems just as possible. Expanding lending, particularly to small businesses, should be a goal for any changes in financial regulation, but there’s no guarantee that making life easier for the industry’s biggest players would have that effect.

Once again, though, the macroeconomic environment is likely to end up mattering more than changes in the regulatory environment. If anything is going to juice lending in the coming years, rising interest rates is going to be it. If anything is likely to have been at the root of the low rate of lending since the crisis, near-zero interest rates from the Federal Reserve are it. In that sense, how the new administration will play a role remains unclear. Trump was openly critical of the low rate environment on the campaign trail, and if Janet Yellen steps down, he may have a chance to nominate a new Chair of the Fed, which could mean he could shape policy there, as well.

Reasons for Hope… and Plenty of Reasons for Caution

As always, the urge to overestimate the role of the government in economic growth is especially strong at the beginning of a new administration. The ability to change the legal framework surrounding different industries can create a certain illusion of control, even if the bigger factors guiding potential growth involve the broader global economy. Investors looking for returns in 2017 should likely be more concerned with oil prices and interest rates than what the incoming Trump administration has planned.

That said, there’s definitely reason to believe that a new approach from a friendly administration could mean certain industries and segments can expect an improved regulatory environment that could fuel gains. Oil and gas producers are likely to have an array of new options available, midstream energy companies should benefit from increased production and a chance to complete controversial pipelines, and the nation’s biggest financial institutions should be able to improve their margins if Trump successfully rolls back portions of Dodd Frank.

Once again, though, there’s reason for caution, as well. Markets have already jumped during the “Trump Rally” that was sparked after Trump’s surprise win in early November, particularly in the Energy and Financial sectors. Whatever the potentially bright outlook for these stocks may be, there’s a chance that a lot of the gains have already been priced in. Still, in the event that things play out as the new Trump administration is hoping, with macro global events lining up with domestic policy, it could mean that gains continue well into 2017.