Stocks Leap On GOP Sweep

11/21/2016


While political commentators and Wall Street strategists are divided on the implications of the election, the stock market has returned a clear verdict. The Dow Industrials surged to all-time highs, while the Dow Transports reached the highest level since May 2015. With the Dow Theory squarely in the bullish camp, our buy lists have 86.6% to 88.1% in stocks.

Republican sweep

As a lesson in why investors should view expert opinion skeptically, the 2016 election is tough to beat. Not only was Donald Trump widely expected to lose, the stock market was widely expected to slump in the unlikely event he won.

The fact that Hillary Clinton didn't dispute Trump's victory helped investor sentiment, as did the unexpected Republican sweep of Congress. With Republicans in control of both Congress and the White House, investors expect tax cuts and higher spending to provide a healthy dose of fiscal stimulus. Investors also expect regulatory reform, with the financial and health-care sectors facing less onerous federal supervision.

Shares of banks and drugmakers have surged since the election. So have retailers and restaurant chains, reflecting expectations of a pickup in consumer spending. Construction stocks have jumped on expectations of higher infrastructure spending.

Of course, tax cuts and higher government spending could result in bigger deficits and higher inflation — both of which bode poorly for bonds. Yields on 10-year Treasury bonds have moved to a 10-month high above 2.2%, up from less than 1.9% on the eve of the election.

The jump in bond yields has already hurt the demand for mortgage loans, raising worries about the outlook for the housing market. Also, investors worry that higher-yielding bonds could begin to siphon money away from stocks.

Such fears are legitimate, and highly rate-sensitive groups like utilities and real estate investment trusts have already been hit by interest-rate worries. But, compared to historical norms, the typical U.S. stock remains quite cheap relative to bond yields.

The median stock in the S&P 500 Index has a trailing earnings yield (earnings/price ratio) of 5.5% — about 3.3% higher than the 10-year Treasury yield. Since 1994, that spread has averaged about 1.3%. All else equal, the bond yield would need to jump to 4.2% for the spread to return to the norm since 1994.

Conclusion

The primary trend is bullish, and interest rates have room to run before they become a major problem for stocks. While we hesitate to chase stocks that have soared on speculation, we continue to seek reasonably valued growers.


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