Don’t read too much into the political meaning of rising stock prices
Stocktake: Even if Trump’s presidency proves unexpectedly successful, investors are likely to witness a bear market during his tenure
Traders work on the floor of the New York Stock Exchange. Photograph: Michael Nagle/Bloomberg
The Dow Jones Industrial Average may be an anachronistic index that means little to professional investors, but it remains the market’s most recognisable barometer. Little wonder, then, that President Trump supporters are claiming the credit after the index last week closed above 20,000.
“Great!” tweeted the man himself, along with the hashtag “#Dow20K”. Dow 20,000 represents a “huge” vote of confidence in Trump, tweeted Nigel Farage. “Stock market performance in six weeks following President Trump’s victory is best among all elections since 1900,” tweeted Trump advisor Anthony Scaramucci.
Sceptics counter that the bull market began in 2009, not November 2016, and that recent gains represent an acceleration of existing trends.
After going nowhere for 18 months, stocks hit all-time highs in the summer, and breakouts from lengthy trading ranges tend to be followed by above-average gains. Earnings, too, have been strong; America’s long profits recession ended last summer and almost 70 per cent of companies are beating estimates.
Still, it would be facile to pretend Trump’s election has not energised markets, or that enactment of some of his policies will not boost S&P 500 earnings. A FactSet report last week noted that more than a quarter of S&P 500 companies that have reported earnings have referred to Trump’s tax-cutting plans during conference calls. Unsurprisingly, most said they would be beneficiaries.
Trump’s tax and deregulatory policies, if enacted, are good for corporate profits and therefore for stocks. Contrary to Farage’s assertion, however, that does not translate as a “huge” vote of confidence in Trump’s ability to boost economic growth. The market is not the economy; don’t read too much into the political meaning of rising stock prices.
Trump can expect a bear market – eventually
Markets may be bullish at the moment but is the rally sustainable, or are indices poised to eventually suffer heavy falls?
Doubters point to high valuations, mainstream economists’ scepticism regarding Trump’s policies, and the geopolitical risks inherent in having an administration run by a thin-skinned novice who prefers “alternative facts” to hard evidence.
Equally, bulls might say valuations have looked high throughout this bull market; that economic growth is accelerating; and that the president’s impact on stock returns is in any case overstated.
Here’s StockTake’s prediction – markets will experience a bear market at some stage over the next four years, although Trump may not necessarily be the cause of it. Why? Well, every president tends to witness at least one severe correction or bear market during their term, as Ritholtz Wealth Management’s Ben Carlson pointed out in a Bloomberg piece last week. There have been 14 presidents since 1929; all but three experienced bear markets. Of those three, declines ranged from 17 to 19.9 per cent, just shy of the 20 per cent level that marks bear market territory. The average loss across each administration was 30 per cent.
Even if Trump’s presidency proves unexpectedly successful, investors are likely to witness a bear market during his tenure. “Regardless of who is in the Oval Office,” Carlson noted, “that’s just how the stock market functions.”
Making volatility great again
Most observers expected Donald Trump to make volatility great again. It hasn’t happened yet. One volatility metric, the Vix index, fell below 11 last week, closing at its lowest point since July 2014. That’s more than one standard deviation away from its long-term average of 20, noted Convergex strategist Nicholas Colas, and lower than 98 per cent of Vix readings over the last three decades.
LPL Research last week noted the S&P 500 had gone 27 consecutive days where the difference between daily highs and lows was less than 1 per cent – the longest streak since 1995.
Markets are oddly calm. Who saw that coming on the night of November 8th, when markets went into meltdown at the prospect of a Trump presidency?
Psychological importance of Dow 20K is overstated
There has been lots of semi-euphoric chatter about the Dow’s breach of the 20,000 level being psychologically important, something that “helps keep the money flow coming”, as Charles Schwab analyst Jeffrey Kleintop put it.
Really? The Dow first cleared 100 in 1906; it took another 36 years before it stayed above that level for good. In 1972, the index closed above 1,000, but spent most of the next 10 years below that level. Dow 10,000 was first breached in 1999, but stocks then suffered another lost decade.
It’s not always bad. The Dow cleared 5,000 in 1995 and kept flying high for the remainder of the decade, while stocks have done just fine since Dow 15,000 in 2013.
Still, the stats confirm the wisdom of Jason’s Zweig’s definition in his Devil’s Financial Dictionary: “Psychologically important, adj. Unimportant; trivial; nonsensical . . . often applied to “milestones” . . . might be psychologically important to the pundits who proclaim them so, but everyone else should regard them as meaningless.”