Via Doug Ramsay Of Leuthold Weeden Capital Management,
Do You Believe This Guy?
Don’t tell The Donald, but the stock market doesn’t take him seriously.
The market took JFK seriously. In April 1962, Kennedy clashed with steel companies after U.S. Steel hiked prices 3.5%, an increase the president called, “a wholly unjustifiable and irresponsible defiance of the public interest.” The S&P 500, already down several percentage points from its fall 1961 high, plummeted 24% over the next two months as the confrontation continued.
Trump, of course, has attacked the pricing of presidential aircraft, military aircraft, and prescription drugs, while threatening to ignite trade wars on multiple fronts—and all in just the last six weeks! But there’s no sign of a 1962-like panic. To the contrary, Twitter-trolling investors have bid the S&P 500 and practically every major index to new bull market highs. Either they see some mysterious silver lining to price caps, tariffs, and trade wars, or they simply don’t believe Trump will succeed in implementing the more anti-business elements of his pro-business agenda.
The market recovered quickly following the 1962 Kennedy debacle, with the S&P 500 rising 80% into a February 1966 cyclical top. We doubt the market will fare quite as well under Trump. But that’s not because we’re skeptical of his policy agenda… or at least the version of the agenda as it exists in early February (which may be very different from mid- or late-February’s).
No, our skepticism stems from the conditions Trump inherits. They’re too good: a nearly full-employment economy, inflated market valuations, and relatively high corporate profit margins. While there are mitigating factors in the short run that have kept us bullish, our expectations on a four-year horizon are restrained by these “initial conditions.” Trump should be restrained, too.
Trump Inherits Poor ‘Initial Conditions’
Yes, Donald Trump may have been born with a silver spoon in his mouth. But from a cyclical (and contrarian) perspective, it might instead have been Barack Obama who was “born on third base”—with the S&P 500 in January 2009 trading at 11.4x Normalized EPS and the U.S. unemployment rate headed toward 10%. Obama certainly capitalized on these “fortuitous” birthrights: the S&P 500 gains of +85% and +53% during his two terms rank second and eighth in performance among the 22 presidential terms dating back to 1928. He didn’t love Wall Street, but Wall Street loved him (as well as Ben and Janet).
We think that stocks in Trump’s current term will fall short of Obama’s gains, mostly reflecting a valuation starting point that’s almost twice as high as Obama’s was—an S&P 500 Normalized P/E of 22.5x. The scatterplot (Chart 1) shows the extent to which the Normalized P/E on inauguration day influences S&P 500 returns over the subsequent four years. While the optimal forecast horizon for most of our valuation tools is somewhat longer (seven to 10 years), a single presidential term is still enough for us to observe a powerful, inverse relationship—with a solid correlation coefficient of –0.63.
If this relationship between initial valuation and full-term returns holds tight, one can expect a cumulative, price-only S&P 500 return of less than 10% by inauguration day of 2021. But there’s plenty of variation around the fitted regression line—including an “upside surprise” in Obama’s second term, when the market rose more than 50% despite an initial Normalized P/E of 20.4x in January 2013. The best Trump can hope for is a similar, outlier result. Then again, he thrives on low expectations.
The heated, partisan bickering that followed the presidential election seems to have finally simmered down. Allow us, then, to rekindle the flames. We’ve just revised a market study that appeared in the November Green Book, deciding that “split” presidential terms (i.e., Kennedy/Johnson, Nixon/Ford) should be considered a single term when tallying market returns, rather than two (as in our original work). This minor revision had a significant impact on the results, which now clearly show that Democratic administrations have experienced (caused??) much better stock market performance than Republican ones. The median, cumulative S&P 500 price gain during Democratic presidential terms is +48.6%, about double the 24.7% gain generated during Republican terms (Table 1).
The revised study puts bragging rights in the hands of the Democrats, but—once again—it’s the initial conditions that seem to be mostly responsible for the disparity. Democrats have had the good fortune to enter office with stock market valuations at much lower levels: the median S&P 500 Normalized P/E on inauguration day is 15.6x, far lower than the 19.3x median for Republicans. Obviously, there’s plenty of room for one to put a partisan “spin” on these results (i.e., Democrats setting up the Republicans to fail).
“Managing expectations” doesn’t seem like Trump’s style, but in the case of the stock market it might not be a bad idea.