President Trump's election has unleashed repressed animal spirits on Wall Street, pushing equity returns higher in the first month of his administration than they have been under any other president since Lyndon Johnson.
The S&P 500 index of U.S. stocks soared more than 9% from November to late February, led largely by sectors poised to benefit from faster growth and inflation, like industrials and financials.
Bank stocks in particular have surged around 20%, on the belief that Trump's policies will not only ramp up economic activity but also push the Federal Reserve to raise interest rates quickly to keep the economy from overheating.
But when euphoria abounds, you often profit by questioning the direction of the herd. That's how investors made real money under the last administration, when stocks you might have thought would have gotten crushed under Obama—like shares of gun manufacturers and Big Oil—outpaced the broad market (see chart).
What's more, "the enthusiasm following the election of Donald Trump has waned a bit as the realities of policy priorities and getting things done in Washington begin to set in," says Liz Ann Sonders, chief investment strategist for Charles Schwab.
That means now is the perfect time to embrace your inner contrarian and look to out-of-favor parts of the stock market that the rest of Wall Street is convinced will get crushed under Trump. Here are a few sectors to keep your eye on.
To "make America great again," the president says the nation must avoid making "stupid" trade deals. Trump has already ended U.S. participation in the 12-nation Trans-Pacific Partnership pact that his predecessor negotiated. Trump even raised the possibility of slapping 45% tariffs on Chinese goods and 35% on Mexican-manufactured vehicles. Not surprisingly, Mexican stocks have fallen by double digits since Trump's victory in November. And Chinese equities have gained less than half as much as domestic shares.
More broadly, keep an eye on emerging-market equities. The possibility that new tariffs could trigger an all-out trade war poses a "yuuge" threat to companies in the trade-dependent developing world.
But despite Trump's tough talk, James Syme, a senior portfolio manager at JOHCM Funds, believes that this administration won't walk the walk on tariffs. He notes protectionist policies would result in higher prices for imported goods, crimping the bottom lines of consumers who fueled Trump's populist movement. What's more, many goods, from autos to refrigerators, are made with parts from all over the world—not just China and Mexico. "We believe the risks from growing protectionism are overstated," says Syme.
Emerging economies are expected to reaccelerate this year and in 2018 as demand for commodities—which still drives many developing nations—recovers from a multiyear downturn. And while the price/earnings ratio for U.S. stocks, based on 10 years of profits, has climbed to more than 28, "the emerging markets are in the teens," says Ben Inker, head of asset allocation for the money manager GMO.
To gain exposure to the fastest-growing parts of the developing world, go with T. Rowe Price Emerging Markets Stock (PRMSX). Earnings for stocks in this portfolio, which is on our MONEY 50 recommended list of funds, are expected to grow more than 13% annually for the next several years. That's more than two percentage points faster than for the broad emerging markets.
Trump rails against globalization and openly attacks companies—like Ford (F)—on Twitter for relocating or maintaining factories in lower-cost countries such as Mexico. The automaker has invested heavily in Mexican plants to make lines like the Focus and recorded its largest number of Chinese sales the same month Trump was elected. Ford shares have trailed the S&P 500 index since that time. But Ford's P/E ratio is now half that of the market. Meanwhile, profit growth is strong, and the stock sports a solid dividend yield of nearly 5%.
For broader exposure to U.S. multinationals, consider iShares S&P 100 (OEF), which owns manufacturers like Ford in addition to tech leaders like Apple.
At nearly every rally during the campaign, Trump called the Affordable Care Act "a disaster" and pledged to repeal and replace Obamacare. He also vowed to use the power of the White House to rein in drug prices. In a Jan. 11 press conference he said the federal government "is the largest buyer of drugs in the world, and yet we don't bid properly … and we're going to save billions of dollars." No wonder big pharmaceutical stocks such as Johnson & Johnson and Bristol-Myers Squibb have lagged the S&P 500 since Nov. 8.
"The greatest force behind the underperformance has been President Donald Trump's repeated assertions that drug prices are too high and pharma and biotech companies should bid for Medicare's business," says RBC Wealth Management vice president Kelly Bogdanov. "To a lesser degree, uncertainty about repealing and replacing Obamacare contributed to health care's sluggish trend."
But Bogdanov argues that much of the bad press is priced in. And in the long run, medical costs will only grow as the country ages, spurring greater demand for health care in general and drugs specifically. Vanguard Health Care (VHT) offers you broad exposure to the sector, with sizable stakes in Big Pharma stocks such as Pfizer and Merck and biotech giants such as Amgen and Gilead Sciences.
One sector that's trailed badly since Trump's win in November is utilities, which has lagged the market by five points. Chalk it up to anxieties over the policies of this president as well as Washington's other most powerful person, Fed chair Janet Yellen.
"There is a long-standing relationship between interest rates and utilities' performance relative to the rest of the market," says Morningstar analyst Ben Johnson. High-dividend-paying utilities are viewed as an alternative to bonds. So when bond yields rise, demand for utility stocks and other dividend payers typically falls.
Today Wall Street expects the Fed to hike rates at least three times in 2017, especially as the economy gets a further boost from the Trump administration's plans for more fiscal spending on infrastructure and defense.
Of course, economists had forecast four Fed rate hikes for 2016—and saw only one. That year utility stocks soared 16%. So you can use this sector as a hedge against Wall Street's rosy forecasts for growth under Trump.
The risk, however, is that demand for dividend income in recent years has driven up utility valuations. The sector is trading at a 20% premium to its historical average, according to FactSet. That's an argument for going with a value-minded utility fund. American Century Utilities (BULIX) sports an average P/E of 15, vs. nearly 18 for its peers.
Market valuations in general are a big reason to be cautious about the Trump Bump. "Valuations were so cheap when Obama took office that decent stock market performance during his presidency was practically baked in the cake," says Doug Ramsey of Leuthold Weeden Capital Management.
Stocks are now almost twice as frothy under Trump, based on P/E ratios using 10 years of averaged corporate profits. So investors expecting prolonged fireworks on Wall Street will likely be disappointed—that is, unless you go against the Trump crowd.