Perhaps you’ve been wondering why the stock market has been doing so well since the Presidential election.
Leading up to the election, it was widely expected that Hillary Clinton was going to win. Virtually every poll showed this. Then when it seemed that Donald Trump was poised to win, the stock market moved downward very sharply that night in after hours trading. But by morning, all of those losses evaporated and the market started trending upward and has posted phenomenal gains post-election.
Why did the stock market move so much when Trump won?
There is this misunderstood concept of how the stock market works. Many think that it moves based on “any” news that comes out (i.e. sales, profits, earnings, etc.). In reality, the market moves based on “new” news that comes out.
If Hillary would have won, this likely wouldn’t have moved the stock market much at all because she was expected to win and the stock market had already priced this in pre-election. A win for her would not have been “new” news.
However, when Trump won, it was SO unexpected (i.e. “new” news) that the markets have risen dramatically, the opposite of what happened with Brexit. But, WHY have the markets gone up so much?
This leads to another misunderstood concept of how the stock market works. Similar to above, many think that the market moves upward based on any positive news. For example, if corporate profits are up you would naturally think the stock market would be up. But that is not true if those profits were already expected to occur. Remember, it’s the introduction of “new” news that moves the markets, not news that was already expected to happen.
In more technical terms, the stock market is known as a “leading indicator”. This means that stock market performance is indicative of future economic growth (or lack thereof). If the stock market is doing well, then this is an indicator that the economy will do well. If the stock market is doing poorly, then this is an indicator that the economy will do poorly.
Post-election, the stock market (which includes me, you, Wall Street, analysts, investors, etc.) ultimately believes that Trump will be better for the economy. Maybe you don’t feel that way, but the stock market as a whole does. This doesn’t mean the markets are correct, it just means that future economic growth is anticipated. And this is why the markets have risen.
Since the election (a little more than one month ago), the S&P 500 (i.e. large company U.S. stocks) is up 5.50%. This in and of itself may seem impressive, but what’s even more impressive is that small company U.S. stocks blew away large company U.S. stocks. The Russell 2000 (i.e. small company U.S. stocks) is up 15.00% since the election. Let me rephrase this: That is a 15% return in one month!!!
Why have small company stocks significantly outpaced large company stocks?
Remember, the stock market is a leading indicator and it is telling us something about future economic growth. This “something” is that small businesses are expected to benefit from a Trump presidency. But how? In my opinion it partly has to do with three major things: taxes, regulation, and health care.
As you likely know, Trump campaigned on the platform that he would reduce business taxes, reduce regulation, and repeal / replace Obamacare. These three things are expected to significantly benefit small businesses; at least that’s what the stock market is telling us. If tax, regulation, and health care costs / burdens are reduced for small businesses then this would free up much needed capital for hiring and expansion, which would improve the economy.
With that said, no one knows for sure if these things will happen. Just because stock market performance is an indicator of future economic growth doesn’t mean that it’s accurate. There have been times in the past when the stock market “got it wrong”.
So, from an investment standpoint, we believe that it’s futile to guess the direction of the stock market. We live in an information age and our belief is that everything known is already priced into the market. The best course of action is to accept stock market prices for what they are and position your portfolio to take advantage of the stock market performance when it comes. For our clients, this means that we position their portfolios to have more exposure to small company stocks than large company stocks. More exposure to value stocks over growth stocks. And more exposure to high profitable stocks than low profitable ones. These are what have historically been areas of higher return in the stock market.
I would love to hear your thoughts on the post-election market performance. What do you think will happen over the next four years? Will it be good or bad for our economy, stocks, and businesses? Please share any comments below.
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