Leading up to the U.S. Presidential election, many voters anticipated that the markets would rally following a Clinton victory and fall following a Trump victory. Trump won, but markets didn’t fall. Instead, they rallied and rallied in a big way. Many U.S. stock sectors advanced on hopes that President-elect Trump’s policies would spur faster economic growth and more corporate profits.
Now we are seeing stories that the stock market advanced too quickly, that stock valuations are too high and that this economic cycle has gone on for too long for stocks to continue to perform. Let’s briefly address each of these concerns.
It is true that stock prices react very quickly to new information. This is actually a good thing and a characteristic of a healthy market. If prices didn’t change quickly, investors could take advantage of the less informed. In the case of the Trump election, investors feel that corporations will be able to generate better results because Trump campaigned on reduced regulatory burdens, lower corporate taxes and infrastructure spending. All of these are favorable policies for corporations and, if they are enacted, should help corporations grow faster or have better profitability.
For the last three years, investors have been concerned with how expensive stocks are. Valuations are measured by metrics like the Price-to-Earning (P/E) ratio and they have surely been higher than they have been historically. However, they aren’t near bubble-like levels and corporate earnings are improving. In fact, corporate earnings are expected to increase by 3.3% in the fourth quarter 2016 and 11.4% in 2017. (Source: FactSet Earning Insight, 11/25/2016) Rising earnings will help moderate valuation metrics.
Finally, we look at the length of the current U.S. economic expansion. At 87 months (as of September 2016), it is already longer than the typical average global expansion of 72 months. However, global expansions that follow financial crisis induced recessions like the one we are in now have historically been longer. If history is any guide, our current expansion could go until November 2017, and it would still be considered average.
If President-elect Trump is successful in implementing many of his pro-business policies and they generate the positive results he intends, there should be plenty of gas left in the market’s tank.