Wall Street investors have made $3 trillion since Trump ascended into the Oval Office, thanks to the record-breaking Trump Bump.
But now there are signs that the most powerful post-election market rally by any American president could be running out of steam.
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Prior to president Trump’s first address to a joint session of Congress, the Dow Jones had managed to rack up 12 consecutive record closes and was looking to achieve a 13th record close, something it has never done in its 120-year history.
Source: CNN Money
But, any hopes for a first home run were dashed after Trump delivered a speech that was bit high on rhetoric, but low on real details. The business community was craving more details about Trump’s pro-business agenda of deregulation, tax cuts, and economic stimulus via higher infrastructure spending.
In his speech, however, Trump adopted a more statesman-like cadence, perhaps in a bid to stabilize his administration after a highly tumultuous five weeks in office that saw him receive the lowest approval rating (44%) of any new American president.
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The president ended up giving little quarter on issues like the promised $1 trillion infrastructure program and a big tax overhaul, preferring instead to dwell more on his immigration agenda and touting his achievements while in office.
Although the more orthodox and less-explosive speech was well received in political circles, the investing universe felt that it offered too little in the way of actual road maps and timelines on key issues.
Not surprisingly, all major indices have been moving lower in the aftermath of the president’s speech.
Dow Jones Industrial Average Index (DJIA) 5-Day Returns
S&P 500 Index (SPX) 5-Day Returns
Nasdaq Composite Index (COMP) 5-Day Returns
Source: CNN Money
Is a market crash imminent after Trump Bump?
A casual look at how the markets have behaved since Trump’s election seems to suggest that the wild “Trump Bump” could be inadvertently setting us up for a major market crash.
The broad-market S&P 500 Index has jumped 11.2% since Trump’s election, corresponding to a $2.5 trillion increase in market cap. The average price-to-earnings ratio for the benchmark stood at 22 on Nov. 8, just before Trump’s election, way above its historical average of 16. Now that metric has been stretched to an even more frothy 25.
Investors have of course been bidding up stocks based on optimism that Trump will deliver on his election pledges to roll back regulation and lower corporate tax from the current 35% to 15%-20%. Lowering tax rates by that much would certainly lead to a nice bump in profits for most companies.
As long as the business community continues believing that Trump’s administration can deliver on these promises, it’s highly unlikely that the markets will come crashing down over the next 4-6 months. A major crash just doesn’t appear to be on the cards.
But, a deeper look at the long-term outlook for stocks based on real numbers suggests that the market will have a hard time sustaining the kind of gains that we have been seeing under the Trump Bump.
Long-term investors in the stock market typically need an 8% annual return on their investment to consider it worth their while. In any case, that’s the goal that most pension funds set for their equity portfolios. For total shareholder returns (capital gains + dividends) to reach that level and at the same time allow the PE ratio to fall to a more normalized 19, earnings would have to grow at no less than 9% per annum over Trump’s possible eight-year term as president. Trump has pledged to grow the economy at 3%-4%. Assuming he’s able to achieve the higher end of that range, that kind of growth would only produce 6% earnings growth per year over his presidency, considerably less than what’s required to justify current stock valuations.
It’s therefore almost certain that we are going to see a market correction in the long-term. That’s, of course, in the unlikely event that the American economy starts growing at a frenetic pace like China’s.
Healthcare sector in focus
The president was particularly livid during his speech about the need to repeal Obamacare and bring down drug prices ”immediately.” Trump followed it by tweeting that he would bring drug price ”way down.”
Trump is previously on record saying the drug industry was getting away with murder in what it was charging the government for medicine. Following the speech, the biotech sector SPDR S&P Biotech ETF(XBI) plunged nearly 2% while the SPDR S&P Pharmaceutical ETF(XPH) declined 1%. Hospital stocks were badly hammered with Tenet Healthcare (THC) and Community Healthy Systems (CYH) suffering heavy losses of 7% and 9%, respectively.
Despite the selloff and impending regulatory changes, traders are advised to approach healthcare stocks with caution. XBI is still up a solid 19.3% in the year-to-date, while XPH has gained 6.3%. This can partly be attributed to the fact that the broad healthcare index is still considerably cheaper than its historical norm. The index is trading at a sizable discount to the S&P 500, as opposed to the norm whereby it usually trades at a healthy premium, due to the perceived growth opportunities.
It’s therefore quite likely that investors will continue finding stocks in the sector attractive, especially in the current market where it’s becoming hard to find good value.
Takeaway for traders
The Trump Bump appears to have taken a breather, as the market begins to get impatient about the details of how Trump is going to execute his economic reform agenda. Apart from the healthcare sector where GOP has already revealed its proposed replacement for Obamacare, Trump’s administration is yet to issue a road map for broad-reaching reforms such as deregulation and tax cuts.
You can expect the markets to remain a bit choppy or, at best, continue grinding slowly higher, until something concrete is placed on the table.
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