Style and Substance

Was the stock market rally just based on sentiment?

Chrysler Tower with Ravenswood power plant in the background. Photo: Eric Drost. Source: Wikipedia

After our presidential election, global equity markets rose about 10%. The common explanation was that a pro-growth agenda could help the economy get out of its doldrums and reaccelerate. This would support profits and the stock market.

With the failure of Congress’s repeal-and-replace attempt with healthcare legislation and other policy initiatives seemingly stalled, shouldn’t the markets fall back to where they were before the election? And shouldn’t investors protect themselves against such a crash?

The short answer is no. Economic data were improving before the “Trump bump.” The latest report from the Commerce Department gives us proof. Fourth quarter economic growth was revised slightly higher, based on higher consumption numbers. This is an important indicator, since consumption is about two thirds of the economy. But the real news was the continued improvement in corporate profits.

Graphics Source: WSJ

Through most of 2015 we had an earnings recession: four successive quarters of lower corporate earnings, pressured by lower oil prices, a strong dollar, and weak global growth. The stock market went nowhere in 2015. Often, corporate earnings are a leading indicator, since companies won’t hire more workers if their profits aren’t growing.

But starting in early 2016, profits began to recover. For all of 2016, profits rose 4.3%, and look to continue their trend – with or without the initiatives that may or may not come from Washington. If this earnings recovery continues, it will end the longest earnings recession since 1987 that didn’t result in a real recession.

Just because the news programs are obsessed by what happens in Washington doesn’t mean we have to be. Stocks lead earnings which lead the economy. Hopefully, corporate earnings will continue to grow.

Douglas R. Tengdin, CFA

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