Gene F. McManus, CPA, CFP®
“Surprise! Surprise! Surprise!” as Gomer Pyle used to say on the Andy Griffith Show. Donald Trump is our president-elect.
As of December 1, the S&P 500 is up 2.7% or 44% annualized; the Dow is up 4.3% or 71% annualized. The bond market is down 2.6% or 31% annualized since the election.
What is going on? Have the markets suddenly become convinced that Donald Trump can pull the United States and the world out of an eight-year economic crawl? Possibly. Does this run up mean that President-elect Trump can? The correct answer? HARDLY.
Optimism reigns supreme currently, but there are challenges to overcome:
Interest rates are still near historic lows.
Despite the meteoric rise of interest rates over the last month, rates are still historically low. This indicates that capital is plentiful and few are willing to take risks to borrow. Low interest rates also indicate that fewer dollars are chasing many goods. In other words, supply exceeds demand produced by the nation’s economy. GDP continues a weak pattern. It improved to 3.2 % for the third quarter of 2016 but this does not constitute a trend.
P/E ratios are very high.
The current Price/Earnings ratio for the S&P 500 is over 25. This ratio represents the price of a share in relationship to the market’s earnings. Historically, this ratio has averaged just over 15. This means that President-elect Trump has to have enough magic up his sleeve to move earnings substantially higher or prices of stocks will fall.
The dollar is strong.
The US dollar has strengthened versus other currencies particularly the yen, the euro, and the yuan. When the dollar strengthens verses other currencies it makes US goods more expensive overseas and is a headwind for US companies attempting to export to other countries. As we all know, the US economy is still the largest in the world, but is very dependent on the world economy.
Have financial markets gotten ahead of themselves?
We think so. A large run-up or decline in asset classes of this magnitude is usually “too good to be true.” That doesn’t mean that the winds have not shifted in a favorable direction, but so far we have had hurricane-force winds when a gentle breeze is more reasonable.