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Majedie's Brass: the case to back banks as Trump tears it up

Majedie's Brass: the case to back banks as Trump tears it up

If world politics is becoming more polarised, then perhaps nowhere is that more evident than in the US.

For critics of President Donald Trump, the list of issues causing dismay continues to grow: from the Mexican border to initiating a possible trade war, and undermining key national institutions such as the CIA.

Many express a fear that he is upending the world order or economic status-quo.

Trump was expected to be disruptive and unconventional. His popularity rating on being elected President was low compared to other Presidents.

However, polls suggest that over the past 12 months his approval ratings have slowly improved, albeit to still low levels.

Perhaps expectations were set too low, and slowly enough people are becoming de-sensitised to his unorthodox style.

Or perhaps he is getting credit for having fulfilled several of his campaign pledges: lowering taxes, initiating policy to address the US trade deficit, strengthening the border with Mexico and retracting Obamacare.

This is in stark contrast to the approval rating profile of most other Presidents, who have tended to be popular upon assuming office, only to see that support erode through time.

In fact, according to FiveEightThirty, Trump’s approval rating deficit versus that of Barack Obama has reduced markedly over the President’s term and is currently just  3.8%, less than that of Obama at the equivalent stage in his administration.

This improvement in popularity will have important consequences if it continues through to the mid-term elections coming in November this year.

Six months ago, it was assumed by many that the Democrats would win back control of at least the House and perhaps the Senate. Now the pundits aren’t so sure.

A strong swing back to the Democrats will likely reintroduce the political inertia that dogged the US in the later Obama years, meaning that nothing gets done on the legislative front.

However, anything less than that and we may see Trump continue to pursue his campaign promises.

Trump has been using his power to effect change through Presidential decrees or changing personnel in key areas.

The latter will have far-reaching consequences where appointed heads to institutions such as the Supreme Court, US Food and Drug Administration or the Federal Reserve will influence policy for many years to come.

This is perhaps most evident in the financial arena, where he appointed new chiefs at eight of the nine regulatory agencies that make up the important umbrella organisation, the Financial Stability Oversight Committee.

Banking is an emotive subject. The Dodd-Frank Act (DFA), introduced in the wake of the financial crisis for fear of a repeat, is at the heart of the current tight financial oversight regime which the Democrats emphatically wish to maintain.

On the other hand, the Republicans have long hoped to tear up many elements of this Act.

His campaign promise to 'do a number on Dodd-Frank' came closer to being realised in May with the passing of a bill that removes several of the onerous elements of DFA.

Although it is a watered-down version of a House bill proposed last year, it nonetheless reduces the regulatory burden quite dramatically for many mid-sized banks, by raising the cut-off for banks deemed to be systematically risky from $50bn up to $250bn.

This cuts the number of institutions requiring detailed stress-tests and strict supervision from 38 down to 12.

Key features of all banks in the past years have been 1) escalating expenses related to ‘compliance’ – the term used to describe spending on personnel and IT systems to enable them to complete the hundreds of pages of regulatory submissions and 2) high minimum capital requirements, with many unable to use their excess capital above this.

Mid-sized banks including our holding, Zions Bancorp, have been keenly waiting for this moment.

They are one of the banks seeing a lifting of their regulatory burden, and as a result will likely see the two drags mentioned above reverse: compliance costs are falling out of the profit and loss account, and with more freedom to deploy their excess capital, they can buy back their shares.

We believe the economy to be late-cycle and profit margins to be extended in many cyclical segments of the market.

For this reason we have shifted our US Equity portfolio to companies offering secular growth, rather than being reliant on the economy.

However, banks are one area that has stood out for us in the cyclical arena as offering attractive risk-rewards.

We continue to favour banks due to reasonable valuations combined with fundamental tailwinds: 1) falling compliance costs 2) benefits of rising rates on revenue 3) branch consolidation opportunities as mobile banking penetration increases and 4) the ability to deploy their excess capital.

All of these drivers contribute positively to earnings growth.

Of course, banks are reliant on the outlook of the economy, but we believe they offer an attractive risk-reward skew versus most other cyclical areas of the market. 

Adrian Brass is manager of the Majedie US equity fund, which returned 44.7% compared to a sector average of 55.5% in the three years to June.

He also runs the Majedie Global Equity fund, which has returned 49.6% over the last three years versus the sector average of 42.9%. 

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