Dow Hitting 20,000? Beware a Stock Market Crash
On the eve of the U.S. presidential election, one in two investors feared a stock market crash. Such was the hysteria that many withdrew from the stock market altogether, seeking safe and boring financial vehicles instead. Yet a recent Gallup poll suggests that investor optimism is at a nine-year high. (Source: “Gallup: Investor Optimism Reaches 9-Year High After Trump Elected,” Newsmax Finance, December 20, 2016.)
But is that a good thing? Surely, Donald Trump’s approval is buoying. Americans have high expectations of the president-elect. The substantial majority (over 60%) believes that Trump will improve the economy and create jobs. But many investors are ignoring the signs of a major stock market crash.
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Trump’s prescriptions could hurt global growth and trigger a stock market crash. Indeed, they could promote risk aversion similar to those we have experienced over the past five years. Market expectations of an improvement in growth initiatives are based on fruits, which could only be seen over the next 12 months. Nevertheless, the bond markets have already built in a rise in interest rates.
Such is the excessive optimism that in November, consumer confidence jumped to 93.8, marking a significant improvement overall in the attitude of consumers to the economy—higher than anyone could have predicted. (Source: “Consumer sentiment index hits 93.8 in November vs 91.6 estimate,” CNBC, November 23, 2016.) Investors seem oblivious to the risks of a market crash.
The index numbers speak clearly. The Dow Jones is on its way to hitting 20,000 while the S&P 500 stock index has gained seven percent since Trump was elected. Presumably, some Hillary Clinton voters’ portfolios have also benefited. But that’s when the markets get tricky.
Crashes tend to happen when investors’ confidence is so high that they start to make mistakes. Or they simply refuse to see the warning signs, which is what happened in 1929, 1987, and—of course—in 2008. That optimism has not yet reached a peak. More time must pass before it translates to bigger stock market participation. (Source: Newsmax Finance, op cit.)
Investors have been cautious for a long time. Donald Trump, like him or not, offers the prospect of change. Had President Barack Obama delivered on job growth, the economy, and wage stagnation, Hillary Clinton would have won.
Trump won the election because he was willing to address these problems, at least during the campaign. Expectations are high, perhaps too high. Indeed, investors should be cautious and aware of the triggers for a stock market crash. The mood will become more realistic as Trump takes office and people start worrying about whether he can deliver.
