Brett Friedman, Winhall Risk Analytics/OptionMetrics Contributor
President-elect Trump has not yet been inaugurated, but investors are busy trying to determine which sectors might be most affected by his administration. So far, four sectors could be potential candidates: defense, pharmaceuticals, energy, and crypto. Although the short term effects are relatively clear, the longer term picture can tell a very different story.
Defense
The President elect’s planned push to aggressively cut the size of government could have obvious ramifications for the U.S. defense budget, which was a staggering $841.4 billion in 2024, or 13.3% of total US spending. To put that in perspective, consider that the defense budget is the largest in the world, by far, and greater than that of the next nine countries combined. US defense spending represents 40% of the worldwide total and over 66% of the total federal workforce (including the armed services). All this makes the defense budget an obvious place to cut spending, which is bearish, at least in the short term, for defense related stocks.
However, the longer term picture is much less clear. As is always the case when reduced spending is promised, it is necessary to separate campaign rhetoric from reality. Although US defense spending is high in absolute dollar terms, it is not when measured as a percentage of US GDP. In fact, at under 3%, it is the lowest it has been since 1999 (it was about 40% at the end of WW2). In addition, there are still several conflicts (in the Middle East, Ukraine, and potentially Taiwan) percolating that may threaten international stability and US interests abroad. And finally, cutting defense spending is great in theory, but unpopular amongst congressmen and regions that have districts dependent on it. Although reducing the size of the defense establishment may be in fashion, meaningful long term cuts may be a tall order.
The defense sector’s conflicting short and long term fundamentals are reflected in its most recent price and volatility action. Soon after the election, the iShares US Aerospace and Defense ETF rallied 7.4%, outpacing the SPX, but soon began declining after the administration’s cost cutting intentions became clear. As uncertainty overhanging the sector increased, its implied volatility followed suit, increasing 2.1 percentage points, or 15.3%, since its post-election low. As the market may eventually realize that meaningful cuts are a ways off, and possibly may never occur, the sector could revert back to its long term trend.
Pharmaceuticals
The presumed policies of a conservative, pro-business administration may appear to be contrary to many of the views of the nominee to head the Department of Health and Human Services, Robert F. Kennedy, Jr. His views on vaccines and weight loss drugs, as well as his criticisms of the pharmaceutical industry in general, could be bearish in the short term for drug companies.
The market appears to be focusing most recently on negative ramifications of RFK, Jr.’s nomination. Recent price and implied volatility action in the VanEck Pharmaceutical ETF (PPH) appears to bear this out. Since the nomination, PPH has declined 3.3% and its implied volatility has increased a full 3 percentage points, or 25% (see below).
As is the case with the defense sector, the longer term picture is much less clear. First, many of the nominee’s views do not appear to sit well with the Republican establishment; his confirmation is anything but a sure bet. Second, the changes that RFK, Jr. envisions might be difficult to implement in a bureaucracy composed of over 83,000 employees operating out of 13 divisions and subject to extensive and well-funded lobbying efforts. Again, it’s important to separate campaign promises and rhetoric from hard reality.
Energy
The President elect’s nominees to head the Department of the Interior and Energy hail from the oil and gas industry and may be naturally inclined to expand leasing of drilling rights on federal lands and to ease restrictions on pipelines and other energy-related projects. At the same time, support for renewable energy, or new technologies, could likely decrease.
Unlike the prognosis for the defense and pharmaceutical sectors, short and long term price and implied volatility action are in agreement. Reflecting this, the Energy Select Sector SPDR Fund (XLE) has increased 5% since election day. More telling, the market seems to be very certain that the new administration will be supportive; over the same period, XLE implied volatility has decreased 3.9 percentage points, or 17.3% (see below).
Crypto, Bitcoin
Trump’s support of the crypto industry is well known and was featured in his campaign. His election, as well as the impending departure of regulators and representatives highly critical of the industry, has led some supporters to believe that crypto could finally be recognized and regulated as a unique asset class, or perhaps even be used to form a strategic bitcoin reserve. Therefore, it is not surprising that bitcoin is up over 33% since election day, and over 105% year to date.
Interestingly, bitcoin’s implied volatility has not increased in sync with its price. Instead, it has decreased 8.1 percentage points, or 12.4% since election day. BTC rallies are usually accompanied by increased implied volatility, not decreased. Apparently, and despite the fact that the practical use case for crypto as a medium of exchange or alternative national currency is still debatable, investors seem convinced that this time is different.
Caveat Emptor, Caveat Venditor
Of course, when the government choses an industry or company to support, directly through investment or indirectly through favorable regulation, there is no guarantee that it will work out for investors. First, the US government has a seemingly endless supply of money and a long time horizon, both much greater than that of most any investor. They can wait a very long time and can absorb extreme losses. Second, the government doesn’t necessarily have to make money; their goals can be socially necessary or politically motivated. Third, the government's support can change overnight as political fortunes wax and wane.
And finally, the government can pick the wrong horse. Case in point: Intel (INTC), down over 45% over the last year, despite more than $20 billion in government support from the 2022 Chips Act and support from the Biden administration. Compare that to Nvidia (NVDA), up over 175% over the same period, or even SPY, up over 29%.
Therefore, relying solely upon government policy or direction to help shape investment strategy can be fraught with risk.
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There is an inherent risk involved with financial decisions. The information in this article is for informational purposes only and is not intended to provide financial advice. Views expressed are those of the author and are not necessarily those of the company.