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2016-12-15 22:52:14
Common Sense: The Market and the ‘Trump Effect’: What Do the Tea Leaves Say?

So much for the “January barometer.”

During the first five trading days of this year, the Dow Jones industrial average dropped more than 6 percent, the worst start to a new year ever for investors.

For all of January, it dropped 5.5 percent, the worst January since 2009 and the depths of the financial crisis.

For followers of the Stock Trader’s Almanac and others who look for patterns in the stock market, those were resounding portents of financial doom.

“As January goes, so goes the entire market year,” is one of the best-known aphorisms from the Stock Trader’s Almanac, an annual compilation of dates, statistics and advice for investors that was first published in 1968 by Yale Hirsch.

Moreover, in presidential election years, the almanac posits that the market’s performance during the first five days of trading will determine if the market ends up or down for the year.

But after a major postelection rally, the market was a hair’s breadth away from the milestone of 20,000 on the Dow, and the S.&P. 500-stock index and Nasdaq were also setting records. The Dow was up 12 percent for the year, the S.&P. 500 was up in excess of 9 percent, and the Nasdaq gained nearly 8 percent.

No barometer, of course, is always right. But over the last 10 years, the January barometer gave false negative indications in 2014, 2010 and 2009, and a false positive in 2011. With its spectacular failure this year, it has been right just 50 percent of the time over the last decade — which means it is essentially worthless as a predictor.

Jeff Hirsch, Yale Hirsch’s son and now editor and publisher of the almanac, acknowledged this week that both barometers had missed the mark this year, but said their long-term record remained intact and that they had accurately anticipated the correction that bottomed out in February. In any event, he has never said that investors should rely solely on the almanac’s predictions in making investment decisions.

Human nature being what it is, that’s not likely to stop investors from searching for predictive patterns, such as the relationship between stock performance and presidential elections, which has produced a bullish signal this year.

The almanac points out that during the first calendar year of a Republican president and a Republican majority in both the House and Senate, the S.&P. 500 has risen on average 14.1 percent. (The market’s track record for a Democratic president and Republican House and Senate is even better at 16.4 percent.)

We’re now in the midst of what some are calling the “Trump effect,” which posits that stocks are poised to soar even more, not just because of historical patterns, but thanks to a new business- and investor-friendly Trump administration.

“If this guy pulls it together and really creates some change, if we see some political functionality and he pushes some constructive things through despite his rants and diatribes, we could be at the start of a superboom cycle,” Mr. Hirsch told me. Then again, he continued, “if he fumbles this, then all bets are off.”

Believers in the Trump effect have gained confidence from the powerful market rally that kicked in after Mr. Trump’s surprise victory.

This week I asked James Stack, president of InvesTech Research, to compare the market’s performance during the 34 days since the election with every other election year going back to 1928. He told me the postelection rise in the S.&P. 500 of 5.5 percent through Monday was the best ever.

But whether further gains are ahead is an open question. Mr. Stack pointed out that all presidential election correlations are of dubious predictive validity because the database is too small; from 1916 through Mr. Trump’s victory in November, there have been just 26 presidential elections over the last 100 years.

In heavily blue places (like Manhattan), there’s an entirely different Trump effect: the belief he’s about to take the economy over a cliff. Investors who support that idea should dump stocks and retreat to the safety of government bonds — though the safety of even those may be suspect, given Mr. Trump’s past threat to renege on the national debt.

This camp, too, can point to historical precedent. After the election of Herbert Hoover in 1928, the S.&P. 500 ran up 9.2 percent by the end of November, the biggest, fastest postpresidential election gain ever. The honeymoon didn’t last long: We all know what happened in 1929.

Mr. Trump himself has emerged as a bearish stock market prognosticator, declaring during the first presidential debate in September, “We are in a big, fat, ugly bubble.” If so, it has only gotten fatter since.

To help navigate these conflicting signals, I turned to Burton Malkiel, emeritus professor of economics at Princeton and author of the classic “A Random Walk Down Wall Street: The Time-Tested Strategy for Successful Investment.”

Mr. Malkiel’s advocacy of the efficient market theory, his many years as a director of the mutual fund giant Vanguard, and his current position as chief investment officer for the automated investment firm Wealthfront have all contributed to the rise of so-called passive investing.

“The problem with all these data people is that you can find correlations anywhere,” he told me this week. “My favorite is milk production in Bangladesh,” which, according to one academic study, explains 99 percent of movements in the S.&P. 500. “It’s true the stock market has done better under Democratic presidents than Republican ones,” he said. “But is that just a spurious correlation? In all likelihood, it is.”

“I hear all the time that the market has gone crazy since the election,” Mr. Malkiel continued. “Is the market too high now? I have no idea, and neither does anyone else. I’ve been around a long time. One thing I can tell you for sure is that nobody, and I mean nobody, can consistently time the market.”

At the same time, he doesn’t consider it irrational that the market has surged since Mr. Trump’s election.

“People who think Trump is going to take us over a cliff don’t have any superior knowledge,” he said. “Maybe he’ll do something really stupid on trade and the economy will go over a cliff. It’s a possibility. But it’s also a possibility that we’re going to have stronger economic growth. My own view is that we’re going to have better real growth in 2017 than 2016, maybe not 4 percent, but 3 percent, absolutely. It’s not completely nonsensical for the market to be up.”

So what should investors — of whatever political leanings — do now?

Mr. Stack said he was telling clients to be cautious, not because of any views about a Trump presidency, but because valuations are getting stretched and the bull market is now the second-longest in the last 85 years.

“That makes me nervous,” he said. “One thing I’ve learned over 40 years of investing is that profit opportunities always come around if you’re patient. Don’t be lured in because you’re afraid the Dow is going through 20,000 and you’ll be left behind. There is no last train out of the station.”

Mr. Malkiel urged investors to ignore their feelings about a Trump presidency. “Whether you think Trump will be wildly successful or he’ll be a disaster, don’t try to move in or out of assets because you think you know what’s going to happen,” Mr. Malkiel advised. He said investors should be broadly diversified, stick to their asset allocation plans and rebalance periodically. “And by all means, keep expenses low.”

Next up on the calendar: the so-called Santa Claus rally, which posits that stocks tend to rise during the last five trading days of the calendar year and the first two trading days of the next, and if they don’t, it’s a harbinger of bad times.

As Yale Hirsch described the phenomenon, “If Santa Claus would fail to call, bears may come to Broad and Wall.”

That, too, proved wildly off base last year.