Stampeding global markets post-election make us question whether the bull still has life. This month, we present a rationale for why it may still have room to run, analyze its underpinnings, and suggest how investors can use market dips as entry points to reposition portfolios and take advantage of what may be a new trend in equity strength.
Stock markets have been on a mini tear since November 9, when Donald Trump surprisingly won the majority of electoral votes. It has been a rally few anticipated, and indeed, the assumption before the election was that a Trump victory would lead to a 5-10% decline in equities. Instead, the opposite has happened. The question now is whether we have only just begun.
That question is certainly related to the overall possible market shift from bonds to stocks, the “great rotation,” about which we and many others have been musing. That rotation, should it continue, will certainly provide the fuel for further equity market strength. But there are other aspects to the recent stock market strength, with the Dow surging toward 20,000 and above. This has clearly been a relief reaction to the election, and already many are speculating that it has gone too far, too fast. Perhaps that’s so, but there are good reasons to consider that we are at the beginning of a new trend.
Yes, it may have only just begun
Skepticism has been the dominant reaction to equities over the past years. Even as US indices have continued to rise year after year, along with global equities for the most part, investors and analysts have routinely expressed caution and advised wariness. The reasons have ranged from “stocks are overvalued” to “markets are being juiced by easy money from the Federal Reserve (Fed)” to “economic fundamentals don’t justify these levels.”
Yet, none of that has mattered. There have been repeated periods of volatility, mostly caused by anxiety in the bond markets, as the Fed ended its policy of quantitative easing and then last year began to signal that interest rates would gradually rise. There also was a global reset in equities and international bonds when energy and commodity prices collapsed in 2015. Nonetheless, stocks in general have been resilient and have trended up.
Then we have a surprising post-election rally. And not just any rally, but one of the best postUS presidential election performances in nearly 40 years (Figure 1). Even more important for the future has been the surge in small-cap stocks, as represented by the Russell 2000. Small-caps often do better when investors believe more economic expansion lies ahead. Investors now anticipate a stimulative kick-off to the Trump administration in the form of tax cuts and infrastructure spending. His administration may also have a bias toward purely domestic US companies, which tend to be mid and small cap rather than the more globally exposed large-cap multinationals.
This rally has been selective, which is another reason to expect it to continue. Rather than all boats rising, particular sectors have done spectacularly (Figure 2) well. Financials and industrials tied to expectations of infrastructure spending have surged, while technology shares that led the market in 2015 and healthcare stocks have both lagged considerably. Earlier this year, dividend-paying stocks, such as utilities and certain staples, did well, and now have lagged. A market surging based on rotation among sectors often represents a more stable foundation for future gains than one in which all stocks are rising. The latter can be a sign of frothy markets where investors are just rushing into equities willy-nilly, rather than making choices based on expectations of strength in future fundamentals.
Then there is the Fed. At its December meeting, the Fed raised the short-term rate to 50 basis points, and signaled its intent for three more increases in 2017. Granted, that needs to be taken as intent rather than a fact: After all, last year the Fed suggested that four rate increases were likely in 2016, and that did not happen. Even though very easy money will no longer be an energy source for equity markets, stocks are rising just the same. Using the Fed as a reason for equity market skepticism will be a harder argument to make.
Finally, there is the long-rehearsed argument that equities have been on an upward trend since March 2009, and that after seven-and-a-half years, the “bull market is getting tired.” Analysts dredge up charts to show how long the “average” bull market lasts, and indeed seven plus years is a long time.
