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Can the Stock Rally Continue?

| February 19, 2017
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Stocks have had a pretty good run since the November election.  As you can see from the graphic below, the S&P 500, a measure of the largest 500 publicly traded US stocks, is up 5.32% year to date and 8.07% over the last 13 weeks.  Notice also the rolling one year performance is up 24.68%



Bonds have been more subdued with the Barclay’s Aggregate US Bond Index up 0.44% year to date and 1.51% over the last year as you can see from the graphic below.


One question that I ask myself is: is the strong recent performance of US stocks attributable to the election of Donald Trump?  And secondly, can the strong performance continue or are we on the verge of a market pullback?


As you can see from the 5 year chart of the S&P 500 below, US stocks hit stall speed from mid-2014 to mid-2016 as corporate earnings plateaued and economic growth ebbed.  I drew a box around the chart to illustrate the choppy sideways market behavior during this timeframe.


But looking at a one year chart of the S&P 500 below, we notice that the trend is clearly up despite weakness heading into the November election.  So one could argue that our current uptrend has been in place for at least a year and well before the November elections.




Further evidence that Trump is not the only factor at play, the graphic below is a one year chart of the FTSE 100, reflecting stock prices in London.  This shows a fairly strong one year trend.



Here is a one year chart of the Nikkei 225, an index of Japanese stocks.  Again, a strong one year trend that pre-dates the lengthy handshake between Trump and Shinzo Abe, Prime Minister of Japan.



Finally, below is a one year chart of the Shanghai Stock Exchange.  This also shows a fairly strong one year trend and there is no Trump Rally in Shanghai that I am aware of.



So my point is that maybe this isn’t a Trump rally at all.  Maybe the global economy is finally getting better after a period of malaise from mid-2014 to mid-2016.  This malaise was characterized by weak corporate earnings growth around the world.


Taking a look at US Corporate earnings of companies in the S&P 500, as of Friday 2/17/2017, according to FactSet:




My interpretation of this is that at 17.6 times earnings, the S&P 500 is at or slightly over its 20 year average earnings level of 17 times earnings.  This begs the question, can our rally continue?  Are we headed for a short term correction?


One of the recent catalysts of US stock prices is the concept of corporate tax restructuring.  Here is an interesting graphic from the Tax Foundation on corporate taxes around the world.  Note the US in Red, has the highest corporate tax rate of any of the OECD nations.


So if corporate taxes fall and corporate profits rise, what would that do to corporate earnings numbers?


One estimate from Bank of America Merrill Lynch suggests that earnings might rise $5 to $6 if the corporate tax rate is dropped to 20%.  Other studies have suggested that for each 1% point drop in corporate taxes, that earnings would rise by $1.31.


In summary,

  • The growth of stocks over the last year is only partially attributable to the election of Donald Trump and corporate earnings are a much bigger factor in the behavior of stock prices.
  • A correction could happen at any time and US stocks appear to be at or slightly over their historical earnings multiple
  • The environment is supportive of stocks and imply that the rally could hold or continue if we get a reduction in corporate tax rates.

Investors cannot invest directly in indexes. The performance of any index is not indicative of the performance of any investment and does not take into account the effects of inflation and the fees and expenses associated with investing.

All investing involves risk, including the possible loss of principal. There is no assurance that any investment strategy will be successful. Past performance is not an indication or guarantee of future results

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