Reality Trumps Expectations

11/14/2016


On Nov. 9, the day after billionaire Donald Trump was elected president of the United States, the Dow Jones Industrial Average closed at 18,589.69, less than 0.3% below the all-time closing high of 18,636.05 set Aug. 15.

Wall Street, known for disliking uncertainty, was reportedly worried about what would happen if Trump won. Those fears proved unfounded, as the S&P 500 Index and Dow Industrials recovered from a weak open to close up at least 1.1% for the day.

Some market reversion is possible — even likely — and we'll wait for the dust to settle before rejoicing. But with the Dow Theory already bullish before the rally, and with corporate profits on the upswing, we remain comfortable with 84% to 87% of our buy lists in equities.

Post-election rallies are unusual (stocks have risen in only about one-third of post-election days since 1928), but not unheard-of. The S&P 500 Index gained at least 1% after four of the last 10 presidential elections, with the biggest increase, nearly 1.8%, after Ronald Reagan's election in 1980.

While the Nov. 9 rally was encouraging, history suggests investors shouldn't read too much into a one-day market move. The last time stocks rose at least 1% after election day, back in 2004, they did nothing over the next year.

Historically, election years haven't been particularly friendly to the stock market, and neither have the years that followed the election. We looked at the Dow Jones Industrial Average's performance for the last 50 years and found that returns for election years (4.2%) lagged the average return for all years (6.3%). The years before elections delivered by far the best returns (13.3%).

The election-cycle trend, while both obvious and powerful over long periods, resembles pretty much every other market trend in the short term: unreliable. The Industrials fell 0.6% in the 12 months ended November 2015, and in each of the last two election cycles, the strongest gains came in the year after the election.

While the timing of elections matters to the stock market, the winning candidate's political party does not. Over the last 100 years, stocks have performed better under Democrats than Republicans, but the factors determining that performance are nearly impossible to quantify. All presidents must cope with their predecessors' legacies, and will in turn bequeath their own issues to successors.

Financials and drug stocks jumped the day after the election, while utilities and hospital shares fell. Only future trading will tell us whether these moves reverse and what new trends develop.

Conclusion

The politically charged among you may be surprised to know that academic research finds no evidence the president's political party affects long-term stock returns. Higher-than-usual volatility in the near term would not surprise us, and if Trump follows through on threats to pick a fight with China over trade, we could see particular weakness in multinationals. However, when it comes to the broad market, we expect the influence of the presidential election to fade as time passes.

Why? Because the S&P 500 Index generated 44% of its revenue outside the United States last year, and because presidential policies are far from the biggest influence on the three most important drivers of stock prices over the long haul — corporate profits, inflation, and interest rates.


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