Playing Defense Under Trump

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Includes: AAPL, AMZN, FB, GOOG, GOOGL, SPY, TASR
by: Williams Market Analytics, LLC

Summary

The security investment theme has become an even more compelling story under Trump.

A recession-resistant, Fed-resistant investment theme.

Avoid holding long-term positions in crowded, index component stocks.

As Donald Trump prepares to ramp up U.S. Federal Government spending next year, opportunities are being created for investors. For the last few years, the equity trade has been dominated by the hunt for yield. Traditional income-oriented investors have fled the bond markets (offering negative real yields in many sovereign issues) and sought out high dividend-paying equities and lower risk blue chip stocks. As investors have piled into consumer staples, utilities, and household name stocks like Apple (NASDAQ:AAPL), Google (NASDAQ:GOOG) (NASDAQ:GOOGL), Amazon (NASDAQ:AMZN) and Facebook (NASDAQ:FB), the price charts of these stocks have begun to look parabolic…a sign of investor exuberance. In our August 26 Commentary, "Survival Tool Kit For the Next Crisis", we proposed several asset classes for investors unwilling to see their portfolios melt down as happened in 2000-2003 and 2007-2009. We cited several real assets in addition to two themes that offer a compelling story going forward (and even more so now under a President Trump).

The first theme, U.S. infrastructure spending, will get an even stronger boost now that we know Trump will be in the White House. We laid out the case for U.S. infrastructure in an article that we wrote a couple weeks ago and designed an index that specifically targets likely beneficiaries of a major federal infrastructure spending bill. Recall that no index existed in the markets comprised exclusively of U.S. companies (the federal government will surely "buy American" in any spending bill) engaged in the areas of infrastructure cited by Trump. The WMA Roads, Bridges, & Water Index hand picks U.S.-listed companies who supply private government contractors in these three areas, notably excluding the sector of energy infrastructure. The infrastructure theme has been underplayed over the past few years in favor of high dividend stocks and passive indexing strategies (which explains why large market cap stocks with higher index weightings are at stratospheric levels). The WMA Roads, Bridges, & Water Index uses an equal-weighted construction to avoid investing in stocks bid up by the recent craze in passive indexing. As such, while the S&P 500 (NYSEARCA:SPY) stands +40% above its 2007 bull market peak, the WMA Roads, Bridges, & Water Index is -32% below its 2007 bull market peak. The historical performance of our index can be found here.

The second investment theme we proposed back in August was that of security. Anyone who travels, attends concerts or sporting events in a stadium, or takes their children to school is aware of the growing presence of security agents, metal detectors, and other screening measures. Terrorism will remain a threat. Elected officials and private companies have no choice but to make significant investments to confront this threat. And the recent election of Donald Trump greatly reinforces this already compelling investment theme. Trump has promised to defeat radical Islamic terrorism. This won't be easy and it certainly won't be cheap. We do not believe Trump's ranting on terrorism are hollow words. Over the past two years he has admonished the current leadership for the Boston Marathon Bombing, San Bernardino, the military recruiting center attack in Chattanooga, the Orlando night club, and the Paris attacks. He speaks with disgust when talking of Muslims celebrating as the World Trade Center towers fell. Trump could prove to be a "loose cannon" that the world has not seen since the leadership during the British Raj. A real war on terror under President Trump seems to be inevitable. Similarly, Trump has been calling for a much stronger US military, which again reinforces the security investment theme. The new president wants to eliminate the sequester on defense spending and increase military spending to boost troop levels and the number of ships and aircraft. He will ask a Republican Congress to reverse cuts to defense spending enacted under the 2013 budget sequester once he takes office and submit a new budget to rebuild the U.S. military, which Trump described as unprepared to confront the threats that the U.S. faces. It is reasonable to expect sales of defense contractors and their suppliers to increase significantly in the next four years.

During the presidential campaign, Trump also hammered the idea of a society of "law and order". Trump is surrounding himself with no-nonsense advisors who push will for more extreme measures to crack down on crime. Stop-and-frisk, equipping U.S. law enforcement and Border Patrol, and making more room in prisons are all realities which we can expect to see under President Trump. We have identified many ways to play this investment theme from buying the stocks of manufacturers of police equipment, such as Taser (NASDAQ:TASR) and its suppliers, to the stocks of providers of private prisons.

Another ongoing security theme is that of cyber-security. While this has been an issue for private companies for some time, the incidents of cyber-security attacks have increased in the past year. Hackers are launching increasingly more sophisticated attacks on everything from critical infrastructure to medical devices to government servers (just ask Hillary Clinton!). Experts say that we are facing an arms race in terms of security. Every minute half a million cyber attacks are attempted. Given how dependent our society and businesses have become on information technology, it's not an exaggeration to say that a "successful" major cyber attack could bring a large portion of the world economy down. Moreover, nations are reportedly engaged in cyber-espionage (China, Russia) against the U.S. The next nation to launch an attack on the U.S. is more likely to do so "anonymously" in cyberspace and not via traditional missiles and arms.

The reality of security threats and military defense building up in the world today is certainly not pleasant. However spending on security and defense will go forward regardless of whether the U.S. dips into recession or the Federal Reserve raises rates. As investors, we try to identify compelling stories that should outperform over time. We see few risks for investing in companies and their suppliers who provide security devices such as airport body scanners, military infrastructure, and cyber-security. These threats will not go away and political and private sector decision-makers cannot risk skimping on spending for security.

We created a unique index that specifically tracks companies positioned to benefit from public and private spending in the aforementioned areas. Our research team looked for firms that have a significant (greater than 30%) portion of revenue derived from business with the U.S. government in the fields of military defense, IT security, and other security services for inclusion in our index. We also worked back up supply chains of firms that provide metal detectors, airport body scanners, detection wands for security agents at stadiums, as well as providers of private residence/business security systems. The WMA Homeland Security Index offers a tiered equal-weight index of 62 companies which stand to benefit from the security investment theme. The index is rebalanced quarterly. The thematic sector break-down of our Homeland Security Index is shown below.

The index factsheet provides further details on the allocation within the index. The historical performance of the WMA Homeland Security Index (WMA911) is shown below in orange against the S&P 500.

Click to enlarge

Conclusion

Despite two brutal bear markets in the past 16 years, many investors still espouse the buy-and-hold investment approach. Over eight years of relentless up-trends in major equity indexes have erased the bad memories of 2000-2003 and 2007-2009. For investors wishing to leave money in equities we recommend considering a thematic approach for your portfolio, instead of holding onto heavily-weighted index component stocks. Indeed (and as usual), the passive, index trade, like all crowded trades, will unwind in a disorderly, painful manner. We believe that the WMA Roads, Bridges, & Water Index and the WMA Homeland Security Index offer fundamentally sound alternatives and compelling stories versus remaining invested in stratospherically-high major index component stocks.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.