USA TODAY International Edition
STOCK SHOWDOWN
If it’s true the big money is made investing in the stock market when share prices are depressed and the economy is in shambles, there’s a good chance the optimism surrounding the “Trump rally” might be overdone.
Future market returns are largely determined by financial and economic conditions that exist at the start of an investment period. Generally speaking, the odds of reaping bigger gains improve when the market and economy are depressed — not when it is at all- time highs and a lot of optimism is already built into prices.
That’s why it’s unlikely stocks under President Trump will generate the returns they did under President Obama. In Obama’s two terms, the Standard & Poor’s 500 index nearly tripled in value, gaining 182%.
That rally followed the biggest stock market decline since the Great Depression. Obama entered office in 2009 with corporate profit growth down nearly 25% from the prior year and the S& P 500 nearly 50% off its then- record high. The market also was aided by low interest rates as the Federal Reserve had slashed its key interest rate to 0%, where it stayed for the first seven years of Obama’s presidency. Low rates stimulate borrowing for things such as homes and cars and also spur risk- taking, which gives the economy and stocks a lift.
The market’s bull run, nearing its eighth birthday, may have less long- term upside potential now than it did in early 2009, despite the euphoria around what Wall Street perceives as Trump’s business- friendly agenda.
“Big picture, if you consider the stock market as a 10- story building, Obama came into office in the basement and had lots of room to climb,” says Brad McMillan, chief investment officer at Commonwealth Financial Network. “Trump is entering office on the eighth floor, with some room to climb but a lot more room to fall if the economy trips.”
Trump has entered office with more optimism than Obama enjoyed. Wall Street thinks Trump’s plans to cut corporate taxes, regulate businesses less aggressively and spend on infrastructure will boost the economy, corporate earnings and stock market. The economy has been recession- free for seven years, economic growth is picking up after a soft spot early in 2016, fourth- quarter corporate profits are set for their best quarterly growth in two years and the S& P 500 and Nasdaq are at closing highs.
The downside is the Fed plans to raise borrowing costs a quarter of a percentage point three times this year. The S& P 500 is trading at 19 times earnings, which means the market is overvalued and vulnerable to disappointment.
An expensive market is, by definition, a market with less runway and one more prone to price corrections or even a bear market, or 20%- plus drop. And while all those things are possible, for now, McMillan sees more gains.
Still, with the economy improving and the job market closer to full employment, Bill Stone, chief investment strategist at PNC Asset Management, warns “a recession is a possibility during Trump’s term given our ( late) place in the business cycle.” In contrast, while Obama was the fourth Democratic president since World War II to avoid a recession while in office, every Republican president since 1900 experienced a recession in his first term, financial research
firm CFRA says.