Written by Jeff Saut

We live in a modern world of acronyms and buzzwords, and the financial industry is certainly no exception. In fact, it may be one of the worst culprits, what with FANG, ZIRP, TINA, BREXIT, QUITALY, BRIC, etc. all entering the lexicon over the last few years...[and] now the new eye-catching acronym to watch, according to Tom Lee of Fundstrat, is CRAP – Computers, Resources, American Banks, and Phone Carriers – which are all levered to the investment recovery, inflation, and deregulation expected over the next year...

...Lee does not see substantial upside for the stock market as a whole in 2017, at least not without a pullback first, but he does believe potential exists among individual areas of the market.

• This line of thinking is consistent with our view that passive indexing may be more frustrating in this type of investing environment because you will be dragged down by the underperforming sectors and the increased volatility may make it more difficult to hold onto positions long enough to achieve the eventual performance.

C: We generally agree, too, that the CRAP stocks should do well in the political and economic landscape that many expect is on the horizon. If inflation does pick up, driven by fiscal stimulus and more robust economic growth, Fundstrat argues that the contemporaneous increase in wages will not hit technology company margins as hard given their reliance on more high-skilled workers, and we, too, continue to advise an overweight of Tech to benefit from the Computers sub-sector. The big acronym of 2015 and 2016, the so-called FANG stocks, may already be coming back into favor, as well, with Facebook Inc. (FB), Amazon.com Inc. (AMZN), Netflix Inc. (NFLX), and Alphabet Inc. (GOOG) all breaking out to new reaction highs last week.

R: We also continue to like the Energy sector for the Resources play, as our fundamental analyst team in Houston still sees upside for the price of oil over the next couple of years and the companies should be run a bit more efficiently after all the cost-cutting that has been implemented. Their current favorites in the space are Oasis Petroleum Inc. (OAS), Unit Corporation (UNT), Kinder Morgan Inc. (KMI), and Tesoro Logistics L.P. (TLLP).

A: There are no shortage of American banks to choose from, either, but Bank of the Ozarks Inc. (OZRK) and Signature Bank (SBNY) are the two preferred by our analysts at the moment. I have actually received some questions lately asking if the run in banks is coming to an end, and not just in the short-term but for good. We think that’s ludicrous considering Financials have largely underperformed the broad market going all the way back to the early 2000s and it’s going to require more than a two-month run to begin to correct that divergence. In the near term, yes, many of the banks have likely come too far, too fast, but pullbacks should still be for buying, in our opinion as the yield curve is largely expected to steepen further.

P: The Phone Carrier part of C-R-A-P is a little trickier, as Donald Trump has already come out in opposition of at least one of the proposed mergers to further consolidate the industry and put more control in the hands of the major players. However, if we do experience a run of broad deregulation across the general business landscape, the big phone carriers could see some benefits in the form of pricing power (per Forbes), in addition to improving demand as the overall economy gets better. Verizon Communications Inc. (VZ), AT&T Inc. (T), and T-Mobile US Inc. (TMUS) are all rated “buys” by our fundamental analysts.

Market Risks

Fundstrat concluded their CRAP report by throwing in some caveats, including the risk that “sloppy White House organization creates confusion on U.S. policy, particularly as tweets become policy." They estimate the new administration could bring with it at least a 5% dip in the first half of the year, something that should come as little surprise given the great run we have enjoyed and should not be a significant concern.

Coming into 2017, the biggest risk, in our opinion, was that no one seemed to be talking about any risks, and I think it’s pretty telling that Tom Lee is the most pessimistic strategist in the Bloomberg survey and even his year-end target is almost exactly where we are now – so not exactly bearish - but risks do exist (and these are just the obvious ones):

• Perfection from Trump and the Republicans is largely priced in over the near term;
• There is bound to be a disappointment at some point – either not enough stimulus or deregulation vis-à-vis market expectations or it doesn’t come quickly enough;
• A few reports I have seen indicate that some businesses may be delaying further investments or other strategic actions until the new administration’s policies become clearer; if they are forced to wait indefinitely it could start to hurt the overall economy;
• The same goes for many investors, who likely held off on selling positions last year with the expectation that lower taxes would be coming. The question now becomes do we see a round of delayed selling as soon as we get a better idea about the tax implications;
• Considering investors everywhere are refreshing Twitter every few minutes to see what Donald Trump will say next, the market is always one tweet away from being scared off certain companies or industries.

2017 Forecast

...[Given the above risks], it is not unreasonable to think we may start to see some weakness in the coming sessions as inauguration day approaches...as profits from the election rally are locked in and we start to get a real idea of how President Trump will differ from Candidate or President-elect Trump and, if enough traders start to believe an impending top is coming, they may accelerate their selling.

To be clear, we don’t anticipate any major correction to occur and we still believe stocks will largely go up in 2017, but a pullback in the 5-10% range would not be the worst thing in the short term and would likely give you a good chance to buy those stocks previously mentioned...