As if another unlikely event is possible for 2016, the Dow Jones Industrial Average is only 244 points, or 1.2%, away from breaching 20,000. It only took 38 months for the DJIA to double from 5,000 to 10,000 (11/21/95 to 3/29/99) but due to two major market crashes and six years of stagnant growth the DJIA has yet to double again in more than 17 years. The index annualized compounded return of 4.15% (excluding dividends) since Dow 10,000 has challenged even the most patient buy and hold investors.
However, the recent level of optimism is remarkable considering this is the same year that the DJIA started January with the worst decline in history. Corporate earnings continue to be weak with seven consecutive quarters of decline to Q2 2016 (Q3 2016 had the first increase in revenues). The weak economy, global decline, political unrest, and uncertainty in Europe, China, and Russia prompt many analysts to forecast recession or worse for 2016. The Federal Reserve even scuttled their hopes of four rate hikes and Central Banks around the world dug deeper into negative rates in an attempt to promote business activity.
With little notice, the US stock market began a slow summer thaw that has turned into a post-election rip-roaring rally having hit 17 all-time highs YTD. According to Barron’s this weekend,
“the post election rally has added nearly 7% to the value of U.S. equities, which comes to a cool $1.7 trillion since the market’s close on Election Day. “
The good news is this recovery in the US stock market does not appear to be all based on emotional hopes of “huge” changes from Washington. Since the summer, several key economic fundamentals have been improving, and the rally may be the result of multiple factors brewing before the election.
The first example is International Exports and Imports. For years we have referenced this statistic as a key barometer to monitor for insights on world finances. After years of declining trade activity since January 2014, both US export and import trade activity have consistently increased since early spring.
The recent US Manufacturing report illustrated below indicates that since the steep decline in new orders in Q2 2015, both new orders and shipments have improved every quarter.
One of the strongest tailwinds President-elect Trump has at the beginning of his term versus the beginning of President Obama’s second term, is a remarkably optimistic consumer. Consumer sentiment peaked at decade high levels early last year as unemployment rates declined. However, minimal wage growth and a persistently stagnant economy slowly eroded consumer sentiment. That is until the election in which consumer sentiment has rocked to near all-time levels.
Econoday has this commentary on the new University of Michigan’s Sentiment Report:
“Post-election confidence continues to build, lifting consumer sentiment by more than 4 points to a 98.0 level that hits the very outside of the Econoday range and is 1 tenth away from the index’s recovery peak hit last year. Consumers specifically cite expectations of new economic policies as the biggest positive. A rise in the current conditions component, up 4.5 percent from November to 112.1, offers an early indication of strength for December’s holiday spending while a gain for expectations, up 4.3 percent to 88.9, points to confidence in the jobs outlook.”
With economic growth at about 4% (nominal), exuberance from investors is typically the catalyst for annual clip expansion. Look at the chart below regarding investor sentiment (blue line) and valuations (red line). What we see here is that when investor sentiment goes bullish, valuations rise. Although the overall growth may be in the 4% range, sentiment from the consumer and capital owners could push valuations and prices higher.
If the rally since election day was principally a “Trump” rally, then investors missed a short-term profit opportunity. Sharp market volatility, whether positive (current rally) or negative (January 2016, Brexit) are difficult to directly capitalize on without extraordinary risk as emotion set the short-term trendline. However, when a trend sustains we can all reduce risk and appreciate our account values. If the rally is the result of improving market fundamentals with the election acting as a tipping point, then investors have only missed the first stage of what may become a longer-term rally. A favorable scenario to sustain this rally is continued economic improvements and President-elect Trump delivering on many of his campaign business friendly promises. Increased holiday retail sales from 2015 and improving Q4 2016 corporate profits could add even more tailwind to the stock market before the Trump family takes residence on Pennsylvania Avenue.
WHAT DOES THIS MEAN TO ME?
Currently, the US stock market is in a technically favorable trend with indications of continuing into early 2017. The upward trajectory of the stock market through 2017 will be dependent on monetary policy by the Federal Reserve, fiscal policies from Washington, and international events. Since 2008, many major countries followed the lead of the US with similar fiscal and monetary policies which yielded similar results of economic stagnation and societal discontent. The robust rally of the US dollar is the result of investors’ betting that the US will be the best-performing economy in 2017. Should policies by the new administration and congress enhance economic growth as the Federal Reserve raises rates, the result may be “exhuberant” for the US and countries that also adjust their strategies.