 |
| The 2016 historic U.S. Presidential Election is unprecedented. For the first time in history, one party will control all three Federal Branches of Government, two-thirds of governorships, and two-thirds of state legislatures. |
Just like you, I too have observed and lived through this historic U.S. Presidential Election. The U.S. Stock Market had quite a week. Stocks jumped higher on Monday due to a likely Clinton victory based on the polls. However, Donald Trump pulled out an electoral victory on Tuesday. The Market decreased by over 5% on Tuesday evening as it became evident Mr. Trump was going to win. Then the Market rallied on Wednesday and it was volatile on Thursday. Many of you may wonder how I am handling the current volatility and how Talguard is doing in this extraordinary week.
I write this note because the political landscape has shifted in a dramatic way and some of the business climate along with it. No one can predict what will happen with all industries based on this election. I do not make rash decisions based on this outcome. This is why I make my investment decisions based on each individual stock’s prospects and its underlying business. I am not opining on the election and I stay away from partisan discussions. I am writing this note as an investor and businessman. I am writing this note based on the facts that we do know and the implications for some of the industries affected.
The market has experienced volatility and will likely do so in the coming weeks and months. This is because an historic election has resulted in a highly unexpected outcome. The market likes certainty. There is an element of uncertainty with the election of a businessman who has never held office and many policy positions are unknown. One thing is for sure, markets also tend to be volatile when one party controls both the Executive and Legislative branches. In this election, I would like to point out that one party will control much more than that. For the first time in history, one party will control all three Federal Branches of Government, two-thirds of governorships, and two-thirds of state legislatures. This is unprecedented.
The Historic Election:
This was a historic election regardless of who won. On one side you have the first ever female nominee to represent one our major political parties whose husband was a President. On the other side you have the first ever business man nominee who has never held any public office. The outcome was a stunner to most people because the vast majority of polls showed Hillary Clinton was ahead. Donald Trump won the electoral count but loss the popular vote. In the United States, the electoral count is the only thing that matters. Thus, he will be the next Commander-In-Chief serving as the 45th President. Furthermore, the Republicans also retained control of the Senate with 51 seats versus 47 for the Democrats and 2 Independents. The Republican Party actually widened its lead in the House of Representatives expanding from a 30 seat advantage to a 46 seat advantage at 239 vs. 193 and it could get bigger with 3 seats still in contention. With a Trump Presidency the Supreme Court will tilt conservative with his vacant seat appointment. It is currently tied at 4 to 4. Now that you have some background on the Election, let us discuss the industries of interest.
Health Care Industry:
The Affordable Care Act in all likelihood will be repealed. The “Obamacare” experiment is coming to an end. As Mr. Trump has repeatedly mentioned in campaign speeches and in his 100 Days Plan, repealing the Affordable Care Act is the first thing he will do as President. This means HMOs will face less regulation. Drug companies may still face pressure amidst a public outcry even with a Republican controlled Congress. Distribution Services will benefit from less likely regulation that was on the table prior to this election. The Distribution Service industry is attractive to me because it has sold off a lot in recent months due to pricing pressure. It is a three company oligopoly as they control 90% of the industry. This development has helped our investment in a distribution company and a drug maker. Both were purchased with a margin of safety given the recent push back on drug prices. We would have done great with these investments if Mrs. Clinton won as well because we bought at a discount. They are fantastic companies that will continue to generate great returns. Mr. Trump’s upset win has caused some of these stocks to jump higher.
Railroads:
The U.S. Railroad Industry has many advantages. The Railroads have a tremendous capital outlay but they also generate a fantastic cash flow stream. The Railroad Industry is effectively an oligopoly and each railroad often has a monopoly in certain regions. The industry has been through a period of soft earnings but that will get a boost from Mr. Trump due to coal and oil. Mr. Trump has vowed to “revitalize the coal industry” that has all but collapsed in the United States. The long term effect is a “wait and see” situation. The Coal Industry has been contracting for decades. It used to account for over 50% of U.S. energy inputs, it now accounts for less than 40%. Coal Industry employment has reduced from 177,000 in 1985 down to 56,000 in 2015. Keep in mind, the Railroads have developed its intermodal units and that is their area of fastest growth. They are less dependent on coal but it is likely there will be increased coal shipments as an added tailwind for railroads.
On the flip side, the Trump Presidency will present several challenges to the Railroad Industry. Mr. Trump has said he will allow the last section of the Keystone Pipeline to be completed. Mr. Obama had vetoed the Keystone XL bill amidst environmental outcry. This would negatively affect railroad transportation of crude from the Bakken Shale. Currently, only Berkshire Hathaway’s BNSF Railroad has lines there so it would have the most to lose. However, other railroads would lose some shipments. The Railroads will also face challenges because of Mr. Trump’s goal of renegotiating or withdrawing from the North American Free Trade Agreement (“NAFTA”). The U.S. railroads are connected to Mexico in 8 major points. Volume could be suppressed if the NAFTA deal is renegotiated or eliminated.
Banks:
Mr. Trump’s victory and more importantly, the Republican’s victory of both houses is a major home run for banks, especially the commercial banks. That can be both a positive and a negative. The threshold for lenders to be deemed a systemically important financial institution will be raised from its current $50 billion. This will benefit midsized banks as they get more breathing room to compete with larger lenders. Regulations around bank capital may be relaxed so they can lend more. Mr. Trump wants to abolish the Dodd-Frank Act but its elimination is unlikely. I don’t want to see a complete repeal of the Dodd-Frank Act. It serves its purpose as did the Glass-Steagall Act in the previous century. Banks control a lot of leveraged capital and you want to have proper regulations in place to make sure they do not take on too much risk.
Banks will likely get less scrutiny on fees. Republicans were already trying to replace the Director of the Consumer Financial Protection Bureau with a bipartisan committee of five members. Democrats opposed this when they held the Executive Branch. Now that Mr. Trump has won, they might relent. Better to have two seats out of five then a Director that appointed by Mr. Trump.
Consumer and Business Products and Services:
The Consumer and Business Products and Services sectors have interesting companies. These sectors offer the chance to own great companies with durable and powerful brands. The Companies in these sectors will likely face less scrutiny in Mr. Trump’s administration. Mr. Trump has made it known that he wants to curtail the Consumer Watchdog program. Keep in mind, consumer protection was already taken a hit from the courts. On October 11, 2016, a federal appeals court ruled that the Consumer Financial Protection Bureau violates the Constitution’s separation of powers by limiting the President’s ability to remove the director who heads the agency. In other words, there is too much power for a single agency director. This agency has been embroiled in partisan politics since its inception as a result of the financial crisis. This is the same agency that I discuss in the Banks portion of my note.
Mr. Trump intends to renegotiate NAFTA or to eliminate it all together. Canadian Prime Minister Justin Trudeau has already stated he is willing to renegotiate the treaty. I believe Mr. Trudeau senses it is better to hear out Mr. Trump then to face a unilateral withdrawal from the treaty by its largest partner. The Trans-Pacific Partnership championed by President Obama and opposed by Mrs. Clinton, Mr. Trump, and the Congressional Democrats will likely be stalled. The caveat here is that most Congressional Republicans champion free trade and many support this treaty. Either way, Mr. Trump has signaled he wants a protectionist policy when it comes to free trade. A few months ago, Mr. Trump stood in front of a Ford Factory and told the crowd he would levy a 35% tax on Ford’s vehicles that it would ship back to the United States if it moved that factory to Mexico. Obviously, this has implications for the auto industry. It also has implications for China and other consumer goods. Mr. Trump’s policy is likely to carry over to Chinese goods and other international imports. There may be friction with China on this issue.
Managing Risk:
Risk comes from not knowing what you are doing. If you do your research on stocks similar to when you bought your house, you will have very little risk. Risk for the market can be defined as probabilities that are affected by many events and outcomes. Risk is also about permanent loss. My investment approach for seeking companies with a strong moat and purchasing at a margin of safety helps to mitigate that risk.
With our interconnected world today, events from the other side of the globe can have ramifications here. The butterfly effect cannot be measured as it creates a exponentially large number of possible outcomes for the better or worse. Asset appreciation in the past 7 years since the Great Recession with slower corporate profits and a decelerating China, there is a higher probability of a downside than upside this coming year. A step up in interest rates will help certain sectors. That is why I am focused on companies that generate strong cash flow even through the last two recessions.
Now Is the Time To Invest More Into Talguard:
There are many unknowns as to where Mr. Trump stands in regards to key national policies. For example, it is not clear what his views are on the oil export ban nor is it clear how “Trumpcare” would work. Of course all companies can be affected by government policies. Although the direction that the political wind blows does help, it is impossible to predict all implications for the business world. That is why I am patient. When the right opportunities arise, I strike and strike hard. More importantly, I focus on an individual Company’s competitive strengths and valuation.
I see great opportunities even in this market where many investors fear high valuations. I have found some fantastic businesses that have experienced slow quarters or one-time fixable issues. The Market has punished their stocks beyond their intrinsic value which has created solid investment opportunities. Remember, I invest for the ultra-long run so these short term concerns benefit our fund every time other investors panic and sell stock of great companies to us at a discount. Rates will continue to rise as the Federal Reserve has made it clear rate hikes are on the board. That will help some industries and hurt others.
Thank you for believing in me. You have my best efforts. I see great opportunities in this market environment. These opportunities can be fleeting so the time to invest more into the Talguard Value Fund is now.
Best,
Dan H. Chen
President
Talguard Investments LLC
Disclaimer Statement
This document and information herein represents the views of Talguard Investments LLC and is not to be considered investment advice. The information herein should be considered a recommendation to purchase or sell any particular security or financial instrument. There can be no assurance that any securities discussed herein will remain in the Talguard Value Fund LP.
This document does not constitute an offer to sell or a solicitation to buy membership interests in the Talguard Value Fund LP. Past performance is not necessarily indicative of future results. All information provided herein is for informational purposes only.
Investment in the Fund will involve significant risks due to, among other things, the nature of the Fund’s Investments (as defined herein). Investment in the Fund is suitable only for sophisticated investors and requires the financial ability and willingness to accept the high risks in an investment in the Fund. No assurance can be given that the Fund’s investment objectives will be achieved or that investors will receive a return of their capital.
In making an investment decision, prospective investors must rely on their own examination of the Fund and the terms of this offering, including the merits and risks involved. Prospective investors should not construe the contents of this letter as legal, tax, investment or accounting advice. Prospective investors are urged to consult with their own advisors with respect to legal, tax, regulatory, financial and accounting consequences of their investment in the Fund.
©2017 Talguard Investments LLC, all rights reserved.