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Stock Market takes Wild, Unpredictable Ride to Double-Digit Gains in 2016

January 5, 2017

 

No year ever demonstrated better than 2016 the most important principle of investing – no one can predict the short-term direction of the stock market and the best way to make money in the long-term is to stay invested. The year offered nervous investors numerous opportunities to bail out of stocks, and many did. After the Dow dropped 1200 points (7%) in the first week of 2016 – the worst ever start to a year – many analysts predicted a crash. Donald Trump himself said that stocks were in a bubble, and Mad Money’s Jim Cramer agreed. But as so often happens, the markets regained their footing, at least until Brexit triggered the next crisis of confidence. Once again, markets bounced back quickly. Then came the election. As investors eyed what was arguably the most discouraging presidential campaign in history, the market trended downward.

 

That brings us to the fourth quarter, when suddenly, just days before the election, stocks reversed course and started climbing. Analysts suggested this was due to improving odds of a Clinton victory. This assessment seemed to be validated on election night, when Trump’s apparent victory was accompanied by an 800 point drop in the Dow on the overnight futures market. But by morning the Dow was down only 200 points. And it kept climbing, ending the day up 250 points. By year’s end the Dow finished up 12%, a dramatic advance of 28% from its February low.

 

Not many people predicted a rally based on the election of Donald Trump. But there is some logic to it. If the new President and the Congress follow through on an agenda of corporate tax cuts, higher infrastructure spending and less regulation, corporate profits will rise, lending support to today’s lofty stock prices and cheering investors. Whether the base of Trump’s support, blue collar working people, will benefit from these policies is unclear.

 

There’s no doubt that how you felt about the election depends on what kind of voter you are. Similarly, how you felt about the market impact of the election depends on what type of investor you are. While U.S. stocks rose after the election, other assets fell. Trump’s plan for tax cuts and spending increases sent inflation expectations and interest rates higher, causing the price of interest-sensitive assets like bonds and gold to fall. It was not a good time to be a stock market bear. Added together, the global value of financial assets probably changed little since Trump’s election, but it certainly got shifted around.

 

With the new year, we cannot help but look toward the future and what 2017 may bring. On the one hand, consumer confidence is soaring, with the expectations index for future conditions rising to a 16-year high. If this translates into higher levels of borrowing and spending, the economy could kick into a new gear with better than 2% annual growth. On the other hand, there perhaps has never been more uncertainty surrounding government policy. When it comes to key economic issues like trade and government spending, the president-elect has as much disagreement with fellow Republicans as he does Democrats. And not all of Trump’s ideas are market-friendly. Conflict over trade threatens the supply chains of U.S.-based multinational corporations. Large deficits tend to drive up interest rates, which raises the cost of borrowing for consumers and growing businesses. For now, the market seems to be minimizing the possible negative effects of Trump’s ideas, seeming to conclude that the Republican party will restrain his efforts in these areas. Perhaps this is the correct view. But 2016 will long be remembered, not just for the election, but for relentless manner in which it crushed the hubris of political and financial prognosticators. Steering one’s investments according to which way the political winds are blowing would be to repeat their folly.

 

 

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