Trump’s market: bear, bull or lamb?

Trump's market: bear, bull or lamb?
(Chris Whetzel / For The Times)

When Donald Trump takes the oath of office later this week, he will inherit the second-longest stock bull run in history, and a market valued at a record $26 trillion.

From Wall Street’s point of view, it doesn’t often get much better than this. And that’s a big challenge for the new president.

The longevity of the current bull, and stocks’ high prices relative to company sales and earnings, have raised the stakes for what’s next. The Dow Jones industrial average, at 19,885, is up 8.9% just since election day — a sign of investors’ lofty expectations for the economy under Trump.


If he disappoints, or his tax, trade and spending policies trigger unexpected or dangerous consequences, stocks could react violently. A new bear market — meaning a drop of 20% or more in the Dow and other indexes — could in turn quickly undermine the business confidence and spending crucial for Trump’s “Make America Great Again” agenda.

It also would erode the retirement savings of the roughly half of U.S. households that own stocks and stoke distressing memories of the 2008-2009 market crash.

But even though another big market downturn is inevitable, it doesn’t have to occur in 2017, or even in the next few years. Continued investor excitement over Trump could drive stocks to new highs this year in a rally that could feed on itself.

There’s another possibility too: Rather than a bull or a bear, the market could temporarily morph into something much gentler — a patient, lamb-like market that isn’t exciting but also does no great harm. Even in hot bull markets, stocks can go quiet for extended periods.

Here’s a look at four potential scenarios for stocks in 2017:

A market ‘melt-up.’

Some market pros see the possibility of 2017 replaying 1987: a surge in share prices stoked by optimism about the economy.

Coming out of the early-1980s recession, U.S. economic growth exploded higher in 1983 and 1984. The pace then decelerated in 1985 and 1986. By the start of 1987, however, a plunge in oil prices set the stage for a new growth wave.

Even though stocks had been rallying strongly since August 1982, they rocketed in 1987. The Dow Jones industrial average soared 44% from the start of the year to a then-record 2,722 in August 1987. A weakening dollar helped boost expectations for U.S. export growth.

Jim Paulsen, chief investment strategist at Wells Capital Management, sees the jump in consumer and business confidence since Trump’s election as a potentially powerful driver of share prices in the near-term — if that mood can be sustained. In December, a U.S. small-business confidence index leaped to its highest level since 2004.

Although the economy has grown since 2009, the slow expansion has left many consumers and investors doubtful that better times can last, Paulsen said. “For eight years, we just haven’t had confidence,” he said. “We’ve had fear.” A reversal could be huge for spending and investing.

A 2017 market “melt-up” is the official forecast of Michael Hartnett, chief investment strategist at Bank of America Merrill Lynch. He sees a 10% jump in U.S. stocks in the first half, in what he terms the “Icarus Trade” — for the Greek mythical character who flew too close to the sun on wings of wax and feathers.

As Hartnett alludes, the problem with market melt-ups is that they often are followed by meltdowns. That’s what happened in 1987: The infamous Oct. 19, 1987, crash slashed 22.6% off the Dow in a sell-off driven partly by computerized trading gone awry.

Despite that collapse, the Dow still posted a net gain of 2.3% for the year — and resumed climbing in 1988. The 1987 bear market was one of the shortest in history, lasting just 3.3 months.

Another market crash like 2008-09.

An obvious danger Wall Street faces is wild-eyed optimism about what Trump can do to quickly bolster the economy.

“The market is looking forward to a combination of corporate tax cuts, a reduction in individual tax rates, fiscal stimulus and deregulation,” said Russ Koesterich, co-manager of investment giant BlackRock Inc.’s $41-billion Global Allocation Fund. “But this is a lot, probably more than any administration can realistically achieve in one year.”

Still, the expectation of a longer timetable for reforms probably wouldn’t be enough to cause a sudden dramatic exodus from stocks.

The greater risk may be that Trump ignites a global economic crisis with trade policies aimed at punishing major exporters including Mexico and China.

Last September, a study by the Peterson Institute for International Economics said that Trump’s anti-import trade proposals — including a 35% tariff on Mexican goods — would likely trigger immediate retaliation by exporting nations against American goods and services.

The result could be “a trade war that would plunge the U.S. economy into recession and cost more than 4 million private-sector American jobs,” the study said.

Absent a sudden economic or geopolitical calamity, however, the market lacks many of the necessary ingredients for another crash, some analysts say.

Liz Ann Sonders, chief investment strategist at brokerage Charles Schwab, said that although many investors live in fear of a 2008 replay, “the conditions that existed then don’t exist now.”

Financial crises and crashes often follow periods of extreme market excesses, such as intense speculative behavior. In 2008, the U.S. housing bubble was the most obviously inflated market. But 2007-2008 also marked the peak in zooming prices for crude oil and other commodities, for stocks in emerging markets such as China and Brazil, and for European stocks and the euro currency, among other assets.

Today, there’s little argument that U.S. stocks are at risky levels relative to earnings. But commodities, emerging markets, many European shares and most currencies remain well below their all-time highs.

What’s more, the U.S. banking system is vastly healthier than it was in 2008. Weak banks were allowed to fail and the survivors were forced to substantially boost their capital cushions against loan losses. A new financial crisis is highly unlikely to be centered in U.S. banks.

That doesn’t do much to mollify bearish analysts who note, correctly, that overall global debt levels have mushroomed since 2008. Much of it was piled on by governments and central banks in their efforts to support their economies during and after the recession. But some types of consumer debt also have ballooned, notably car loans and education loans in the U.S.

Albert Edwards, global strategist at French bank Societe Generale and a notorious market bear, believes that record high corporate debt will be the “vortex” of trouble leading to the next recession.

Still, debt poses the greatest risk when economies are slowing — not when they’re accelerating.

The Paris-based Organization for Economic Cooperation and Development last week said its latest data point to a pickup in growth this year not just in the U.S. but also in most of the rest of the world.

A ‘typical’ bear market.

Forecasting a bear market drop of 20% or more in 2017 might seem the logical call to anyone who has bet on red or black in roulette. The blue-chip Standard & Poor’s 500 index has recorded positive total returns (including dividends) every year since 2009. If you think of that as landing on black eight straight times in roulette, the odds of red in 2017 would seem high.

Besides that, the current bull run now is 94 months old. Only the 1990s’ advance was longer, at 113 months.

But history has demonstrated that bull markets don’t simply die of old age. Something has to kill them. And often the killer is the onset of a recession that slashes consumer and business spending.

This time, though, few of the classic early-warning signs of recession are present. Just the opposite. “For the first time in nine years it can be said that the economy is hitting on all cylinders,” said James Stack, a market historian who heads InvesTech Research in Whitefish, Mont.

An index of so-called leading economic indicators tracked by the Conference Board research group continued to edge higher in 2016. By contrast, that index was plummeting well before the starts of the last two recessions, in 2001 and 2008-2009.

Another argument against a bear market taking hold: U.S. corporate earnings began to rebound in the third quarter of 2016 after five straight weak quarters. Analyst estimates now forecast a 12% jump in S&P 500 profit in 2017, said Sam Stovall, chief investment strategist at research firm CFRA in New York.

Analysts often are overly optimistic, Stovall concedes. “Yet the new Trump administration is promising tax cuts and economic stimulus from an increase in infrastructure spending, which may justify leaving the 2017 estimate at 12%, or push it even higher,” he said.

Given how high stock prices are compared with earnings, a profit surge may be essential for keeping the bull market alive. The average blue chip stock is priced at about 23 times per-share earnings over the last 12 months, according to market data firm Ned Davis Research in Venice, Fla.

InvesTech’s Stack calculates that price-to-earnings ratios have been in this nosebleed range less than 11% of the time since 1928. He also notes that bear markets can occur in the absence of recessions. That was the case in 1987.

With or without recessions, high stock valuations are “almost inevitably resolved by a new bear market,” Stack said. He thinks the odds increasingly favor a market peak this year, and a bear market to follow.

How bad? Every bear is unique, but they typically take back about half of the previous bull market’s gains, Stack said. If that holds true this time, the market could drop about 40% before bottoming. That would be much less than the financial-crisis plunge of 57%, though still quite painful.

But for long-term investors, bear markets should be viewed as opportunities — the chance to buy low.

Neither bull nor bear

A final possibility is that stocks could simply stall out for a lengthy period, as many investors wait to see what happens with the economy under Trump. There could be intermittent rallies and sell-offs, but nothing dramatic for the market overall.

A “lamb market” is one animal analogy. Wells Capital’s Paulsen offers another: “A ‘bunny market.’ Because it’s hoppy but it doesn’t go very far.”

Admittedly, the idea of a sustained benign market at current record share prices will sound to some like famed economist Irving Fisher’s declaration, just before the 1929 market crash, that stocks had reached “a permanently high plateau.”

Yet there have been plenty of times when the market has temporarily run out of gas. In the current bull, it happened in 2011 and again in 2015.

The stars would have to align perfectly this time, analysts concede. The U.S. and global economies must avoid massive shocks. Corporate earnings must continue to rise, even as worker wages pick up. And the Federal Reserve’s program of raising interest rates must remain on a slow track.

Some market pros say the most important underpinning for stocks worldwide today is the belief that the risk of a global deflationary depression has passed. The long-term bullish case is that governments, particularly the U.S., are embracing growth policies again.

The jargony term is “reflation”: growth with a mild pickup in inflation, but not a rabid inflation.

“Inflation is toxic to stocks. Reflation is not,” said Schwab’s Sonders.

Ed Clissold, chief U.S. strategist at Ned Davis, said his firm’s research supports the idea that the bull market that began in 2009 is a “secular” one — meaning the long-term trend points up, even though bear markets will periodically interrupt it.

The last two secular bulls ran from 1982 to 2000 and from 1942 to 1966, both periods of healthy economic growth.

If investors believe in the secular trend, Clissold said, then “the buy-the-dip mentality still makes sense.”


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