The catch-up trade? Caught off guard this morning. I am sure some of you were not. I am also sure that some of you were. Me? I'm always a bit cautious around events. Regular readers know that over recent months, I had increased exposure across a few areas that will now be more desirable. Regular readers also well know that I have been highly exposed to the tech sector for years. That's been a winning trade pretty much since tech has been a thing. This morning, however, it appears that the change in leadership that markets had experienced through the fourth quarter of 2020 might just have some legs to it.
Do you? Do I? Do we need to make an adjustment? Not sure? Okay, let's think about this. Should the Democrats end up representing the state of Georgia twice, as now appears likely, there would be increased risk of change to the status quo. In other words, the Democratic party with control over both the Executive and Legislative branches of government would have at least a two year window where there will be an effort to get things done that might have otherwise been out of reach.
What Happens Now?
GDP expectations? Probably revised higher on expectations for increased spending. Keep in mind that the recent $900 billion Covid-relief package started out as a $3.4 trillion idea in the House of Representatives. (Not sure if growth in public spending is nearly as beneficial longer term as actual organic economic growth.) Movement is already apparent all over the financial markets. The most obvious movement, at least early would be in U.S. dollar weakness, and in higher yields at the longer end of the U.S. Treasury yield curve. Markets are anticipating increased deficit spending at the federal level as the Federal Reserve Bank continues to expand the monetary base in order to create the necessary funds. However, the Fed is far more likely to pin the short end of that curve in place than they would be to keep on buying 10, 20 and 30 year paper into perpetuity.
This will steepen the yield curve. As the vaccines roll out, and parts of the economy try to reopen later this year, the velocity of money will accelerate as small businesses seek credit, and lenders with cash in reserve finally see benefit in meeting such demand. This in itself will benefit banks, other lenders, and small caps. Into these groups as well as into the Materials sector (based on that softer dollar elevating commodity prices), funds will likely rotate. As the federal government will now also be far more likely to put together an infrastructure rebuild package, the Industrial sector will benefit as well.
Where these funds come from, as far as that rotation comment comes from, is not too hard to figure out. Higher yields will attract investment that might have in a different environment gone into growth stocks, or high tech. These same stocks will then get whacked with higher corporate tax rates (not to mention increased regulation that may hit the banks later on as well), and then there are the investors themselves who may very well face capital gains tax rates that rival income tax rates, even though there is risk in investment that does not exist in simply working as an employee for someone else. There will then be less investment. Maybe a lot less. That's common sense.
Should the cards all fall in the way just described, the air will be let out of the tires across software (cloud) stocks, across semiconductors, across hardware, and even some biotech. Only the Renewable Energy industry, which is classified as tech and not as energy, stands to benefit within the sector.
Yes, I am going to be giving haircuts to a number of my tech stocks. Salesforce (CRM) , and Microsoft (MSFT) , are close enough to revised panic points to make me have to watch them today. I will not exit these names, by personal mandate, I have to sell something should these levels crack.
I would like to add a bank. I am already in JP Morgan (JPM) fairly large, and in US Bancorp (USB) to a lesser degree. I have always liked United Rentals (URI) as an infrastructure rebuild play. Just an idea, but if I wanted to get long 100 shares of Bank of America (BAC) and 100 shares of URI, but not at this morning's prices, how would I go about it? Here's a scenario that will surely change as quickly as time passes, but you'll hopefully see the idea. Bank of America reports on January 19th. United Rentals reports January 22nd.
Actionable Ideas (in minimal lots)
- Purchase 100 shares of BAC at or close to the last sale of $31.30.
- Sell (write) one BAC Jan 22 $32.50 call for roughly $0.60.
- Sell (write) one BAC Jan 22 $30.50 put for about $0.50.
Net Basis: $30.20
Notes: Profit is capped at $32.50 for two weeks (+7.6%). Equity risk is doubled below $30.50 upon expiration.
- Purchase 100 shares of URI at or close to the last sale of $253.60.
- Sell (write) one URI Jan 22 $257.50 call for roughly $7.10.
- Sell (write) one URI Jan 22 $242.50 put for about $5.05
Net Basis: $241.45
Notes: Profit is capped at $257.50 for two weeks (+6.7%). Equity risk doubles below $242.50 upon expiration.