Irrational Exuberance Redux? Trump’s Bull Market May Be Headed for a Fall

In Perspectives by Joe Sullivanleave a COMMENT

It’s doubtful whether Donald Trump is on his way to making America great again. But one thing that has been going great since he got elected is the stock market.

From election day through March 1, the Dow Jones Industrial Average has climbed more than 15 percent to a record 21,115. This jump represents an extension of what had already become one of the longest and most robust bull markets ever. The Dow’s 219 percent increase since a Great Recession bottom of 6,626 in March, 2009, ranks second only to the 518 percent run-up recorded during the 13-year bull market between 1987 and 2000, For 13 consecutive days in late February, the Dow set a new record high each day, which is yet another record.

Since the stock market had been relatively flat for most of 2016 prior to the election, one has to conclude that Trump’s surprise victory gave impetus to its post-election surge. The conventional explanation is that investors collectively concluded that a Trump administration would spur economic growth or at least corporate earnings on which stock market valuations tend to be based.

Since the economy as well was already approaching its second-longest expansion on record (exceeded only by the 1991 to 2001 period), that also seemed like a leap of faith. But Trump was promising big tax cuts (especially for corporations), increased defense spending, a trillion-dollar investment in infrastructure, and no cuts in Social Security or Medicare. That added up to a hugely stimulative fiscal policy because there’s no way promised cuts in non-defense federal spending could begin to offset the deficits beget by revenue reductions and pump-priming. Indeed, Trump was quoted by Fox News as saying, “A balanced budget is fine. But sometimes you have to fire the well in order to really get the economy going.”

That’s about what Ronald Reagan was saying in 1981 when he pushed through the big tax cuts that Reaganomicists were claiming would stimulate the economy sufficiently to generate enough revenue to offset the tax-rate reductions over time. What resulted instead was a huge federal deficit that drove interest rates to record levels, stifling the economy into a recession yet also prompting Reagan’s 1982 tax increases, the largest of the post-war era.

When it comes to the stock market, the Standard & Poor’s 500 Index (considered a better proxy for the overall market than the Dow) is already approaching a valuation peak relative to earnings that’s only been reached twice before. The guru of such valuations is Yale economist and Nobel laureate Robert Shiller. His preferred way of calculating the S & P’s price/earnings ratio is to use a 10-year average of earnings as the denominator to smooth out cyclical effects.

The Shiller PE Ratio, as its known, has averaged about 16 over the long haul. Only twice has it exceeded 30. The first time was just prior to Black Tuesday in 1929.

The second time was in the late stages of the bull market leading up to the bursting of the so-called dot-com bubble in March 2000, after which the S & P declined by nearly half and the NASDAQ by a whole lot more. Indeed, it took 15 years for the NASDAQ to recover to its pre-bubble level.

As of March 1, the Shiller PE Ratio was perched at 29.52, having risen from just over 25 since last November’s election. So it wouldn’t take much to push the ratio above 30 once again. That doesn’t necessarily mean the sky is going to fall imminently.

In December 1997, then chairman of the Federal Reserve Board Alan Greenspan famously warned about “irrational exuberance” in the markets, a term that also happens to be the title of a Shiller book. At that time, the Shiller PE Ratio had just exceeded 30. But it kept on going up for over two more years before peaking at 44.2 on the date the dot-com bubble burst in March 2000.

As an old adage goes, people who don’t learn from history are destined to repeat it. But in this case history suggests a Trump bull market could have considerably more lift left before it comes tumbling down, possibly bringing Donald Trump down with it.

Joe Sullivan
Columnist

Joe Sullivan is the former owner and publisher of Metro Pulse (1992-2003) as well as a longtime columnist covering local politics, education, development, business, and tennis. His new column, Perspectives, covers much of the same terrain.

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