It’s challenging to predict what will happen following the election of Donald Trump as President of the United States, because he may lack the full support of the Republican Congress and may refine his policies as his team gathers information from business leaders, but we can say with confidence that the near-term uncertainty surrounding the performance of many industrial stocks just increased.
Trump’s anti-free-trade rhetoric and policy uncertainty has led to an initially weaker U.S. dollar, which combined with talk of infrastructure spending and tax cuts seems to be pushing inflation expectations upward. This could result in U.S.-based manufacturers being more globally competitive against Japanese and European peers. However, increased inflation, expanding debt costs, and the erection of trade barriers could offset enhanced competitiveness through higher costs and faltering global demand.
What Trump Means for Stocks
Across Morningstar equity analysts’ industrial coverage, U.S. and European defence contractors stand out as winners, while our outlook for other sectors is more mixed. We’re concerned about the impact of slowing trade and air travel hitting transports, aerospace manufacturers, and airlines. While we think the Trans-Pacific Partnership would be positive for Japanese automakers, we see the future of U.S. trade policies with Mexico as the key development for U.S. auto names.
Heavy-equipment firms, which like automakers are oriented to global markets, should benefit from a weaker dollar, but the prospect of higher debt costs could hurt their financing businesses.
For homebuilders, we think the election outcome may actually spur increased consumer confidence for some Americans, and this could provide a housing tailwind. Finally, we don’t see much of an impact on the industrial gas companies we cover; engineering and construction firms might benefit from greater infrastructure spending, an intention Trump highlighted in his acceptance speech, but we take a cautious stance on real increases.
Defence Is the Sector Most Directly Affected
All the U.S. defence companies outperformed the wider stock market November 9. We think the reduced possibility of a lengthy continuing resolution, the potential for near-term increases in defence spending, and a flight to safety drove these stocks higher as opposed to the potential for significantly faster long-term growth in U.S. defence spending.
Earlier this year, we assessed four variables as key drivers for U.S. defence spending: the threat environment, the government’s fiscal health, the defence budget cycle, and politics. At the time, we posited that these factors were flashing green and that U.S. defence budgets were on the cusp of a sustained upturn regardless of the election. Nothing that has transpired since the election has changed this view.
Under a Trump administration, we do think defence budget growth will come in closer to our bull case, which envisions the total Department of Defence budget going above $650 billion in government fiscal year 2019. Moreover, near-term spending could move upward in the current government fiscal year 2017 as a result of an increase in overseas contingency operations funding.
The prospect of a continuing resolution running well into next year has also been greatly reduced, and the resulting uncertainties surrounding defence funding and new program starts have also lessened, in our view.
Spend, Spend, Spend for the Armed Forces
From his policy speeches, we know that Trump advocates higher troop levels, more ships and submarines, and a greater number of fighter aircraft. We will get a more concrete view of Trump’s defence priorities when his administration issues its first budget request in February 2017, noting that the lead time required to build the DoD’s budget places limitations on the changes a new administration can realistically make.
Looking abroad, European and Asian allies may rethink their security arrangements with the U.S. under a Trump presidency. Trump has called for increases in defence spending from NATO countries and appears open to greater militarization across the Asia-Pacific region. We are convinced that our existing growth forecast for European defence budgets coupled with significant Asia-Pacific defence spending increases continues to be correct. These spending shifts should open more revenue growth opportunities for domestic defence contractors in Europe and Asia while also creating more international opportunities for U.S. firms. Unsurprisingly, European defence names like BAE Systems (BA.) and Leonardo (LDO) were up strongly following the U.S. election.
Global Trade and Commercial Aerospace
Across the commercial aerospace sector, our outlook is a bit less sanguine than in defence. Shares of the two large commercial aircraft manufacturers, Boeing (BOE) and Airbus (AIR), increased following the election. However, we’re a bit concerned that Trump’s tough trade rhetoric might translate into action and create headwinds for global trade and air travel demand. This could crimp new aircraft orders and potentially lead to deferrals or cancellations. Wide-body planes like the B787, B777, and A350, which were already facing a soft market, could suffer disproportionately, in our view.
In addition to these broader trends, Trump has criticized Boeing’s recently announced plans to open a Chinese 737 completion, and we think Boeing’s Chinese orders – China accounts for an estimated 20% of the company’s commercial aircraft backlog in units – may be vulnerable. While it would be nearly impossible for the Chinese to satisfy demand solely through more domestically produced C919 aircraft, we could envision a scenario where the Chinese react to tougher U.S. trade policies by funneling more narrow-body orders to Comac, China’s national champion, and favouring Airbus’ aircraft over Boeing’s.
Mixed Bag for Diversified Industrials
Trading in U.S.-based diversified industrials has been mixed but trending positive as the market digests Trump’s plans to boost the domestic economy from within by easing corporate taxation and protecting American jobs, while keeping a watchful eye on global trade agreements.
Companies like General Electric (GE), United Technologies, 3M, Emerson, and Parker Hannifin PH have deep-rooted, century-long histories as American employers, and such companies are likely to benefit if Trump’s policies support an industrial renaissance on U.S. soil.
In addition, with Trump calling for corporate taxation reform, we envision the potential for corporate tax breaks to be awarded to companies that invest in U.S.-based manufacturing capacity and research and development.
That said, over the past decade, most diversified industrials have relied heavily on selling capital goods outside the country to take advantage of above-average growth rates in developing economies. Companies such as GE, United Technologies, Honeywell, and Emerson all derive more than half of sales outside the U.S. and have invested heavily in global operating footprints for decades in order to maximize labour, manufacturing, and supply chain efficiencies in support of these businesses.
Moreover, protectionist trade policies could backfire as other countries reciprocate and enact tariffs on U.S.-made goods. Already, we’ve heard from companies like Emerson and Honeywell that China, with its burgeoning industrial landscape and growing middle class, prefers to buy from China first, Russia second, and the U.S. as a last resort. This could exacerbate the slowdown in sales that the U.S. industrial peer group has recently faced.
