All too often investors make the mistake of projecting onto the stock market their hopes and fears relating to current events. It’s almost as if they view the market as a reflection of the national zeitgeist: if we are feeling good about current events, we buy stocks and markets go up, while they drop when we are feeling worried or depressed about the daily news.
This phenomenon has manifested itself of late in talk of a “Trump Rally” in U.S. stocks. According to this theory, stocks have been gaining in value since Trump’s election because investors are happy to have a business-friendly, regulation-hating president who has vowed to cut taxes and spend big on infrastructure. Investors are buying stocks in anticipation of economic growth that will follow from the new administration’s initiatives, the argument goes.
This is not consistent with how the markets actually operate. It has long been known that political events, such as presidential elections, assassinations, wars, budget disputes, and the like, have only very limited and short-term effects on markets.
Many ordinary investors tend to overestimate the effects of those events on stock prices, because they hear about them daily and they have a top-of-mind effect.
What ordinary investors don’t often pay attention to are the medium- and long-term trends in corporate earnings and profitability. They are the principal drivers of stock prices. If a particular company or industry is experiencing growth in revenues and profits, then shares become more valuable and professional investors are willing to pay more. When profits fall, companies generally become less valuable and shares get sold, driving down prices.
It’s a very simple equation that governs the day-to-day fluctuations in stock prices. Hordes of analysts and computers continually evaluate new news about corporations and the environments in which they function, searching for winners and losers based on earnings.
Donald Trump’s first several months in office have coincided with the biggest jump in corporate sales and earnings in several years. As each earnings announcement has been made, investors have reevaluated the prices they would pay for stocks, pushing prices up and sending stock indices to record levels.
The 13.5% growth rate in earnings reported by Standard & Poor’s 500 companies for the first quarter is the highest year-over-year growth since 2011, the information service FactSet reported.
This phenomenon has been playing out around the world as economic indicators and corporate profits have pointed to an upturn in economic momentum. As long as this trend continues, it is good news for stocks, no matter what Trump or any other world leader does.
Richard Schroeder, CFP®
Chief Investment Officer
