Post Trump Rally
By Julien B. Booth
March 7, 2017
I hope this note finds doing well and enjoying the emerging Spring.
The phase shift in Washington DC, in the markets, and in the media has been nothing short of stunning. These are the moments that make markets so intoxicating for active participants – not necessarily for investors.
Behavioral factors (denial, exasperation, fear etc.) can be damning to generating better than average returns. This election season was no exception.
We choose not to opine on the current administration (career risk) but do note a substantially more business friendly/regulatory tone. Because sentiment so influences decision making, the past eight years of sub-standard recovery have likely dulled investor appetite, until Mr. Trump came along. The markets have spoken, +12% since November.
Everyday we wake with the general idea: Given the macro circumstances, where is Value TODAY?
For the past 2-3 months…it was merely holding the high yield and floating rate/adjustable positions we have owned for several years now (risk spreads were compressing = appreciation in high yield – see graphic 1.1). High yield returns were fantastic last year.
Where is Value TODAY?
Several months ago we wrote about an obvious, but somewhat unfollowed security/opportunity with compelling investment characteristics – perpetual preferred and/or hybrid subordinated notes of the major banks. https://www.brcwm.com/2016/08/19/t-bones-in-a-yield-starved-world/
I will not belabor the specific investment thesis. Net, net the takeaway is the major banks have dramatically better financial ratios/tangible common equity/liquidity than well before the financial crisis of 2009. Trump’s election + sentiment change (thus far) has been tremendously positive for banks vs. the prior administration. The underlying credit quality has only improved. (graphic 1.0)
Perpetual Question: How do they act in a rising rate environment? – was answered during the post election interest rate spike – no meaningful change in value. The market values of the hybrid and preferred etc. were stable to positive.
Positive rate trends only serve to increase the credit quality of the major banks (BAC attached).
Furthermore, many of these securities are QDI eligible (15% tax rate), making their net, after tax returns very compelling vs fully taxable equivalents.
For moderate investors we believe these securities offer compelling value. 6-7% returns with low/moderate risk is just as attractive today as in August.
Disclosure: we own and will continue to purchase floating rate/hybrid/perpetual preferred of the major U.S. banks.
Thank you for your interest in Forest Capital and Sixty Guilders Research.
Forest Capital Corp.