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The optimism around Republican Herbert Hoover’s election was so great it led to the Wall Street Crash followed by the Great Depression

If President Donald Trump’s campaign slogan of “Make America Great Again” applied only to US stock markets then he would already be delivering on his promises …in spades. US stock markets are at all-time highs following two terms of Obama and the pro-business policies expected from the Trump administration.  However there are precedents for this kind of high expectation from stock market bulls. Historians point out that equity markets reacted very favourably to the business-like approach of the incoming Hitler and Mussolini administrations. The optimism around Republican Herbert Hoover’s election was so great it led to the Wall Street Crash in 1929 followed by the Great Depression. More recently the so-called dot-com bubble saw valuation metrics being abandoned for the best website advertising and a back-of-the-envelope business plan.

On Friday (February 17) the S&P 500 closed at 2,351.16 for a gain of a whopping 12.75 per cent on the 2,085.18 level of early November (4th). The S&P is up a staggering 23 per cent on the levels of 19 February 2016. For comparison the Dublin ISEQ index is up 11.8 per cent in the past year and fell 2.72 per cent in the past month. US stock markets have always had a fancy valuation justified by the brand of Wall Street as a bastion of capitalism supported by successive pro-business administrations. Equity markets should reflect the expectation of future earnings (although some psychologists would argue that they reflect human’s basic optimism). The US market is now trading on a very frothy 22 times trailing 12-month earnings. In other words if you buy an average stock you are paying 22 times the earnings per share in the last published period.  The Cyclically Adjusted Price-Earnings ratio (or Cape) is on a reading of 26.

Market watchers note that there are many Trump pro-business policies built into those fancy valuations. Trump has made it clear that he will reduce regulation. (Anyone recall Reagan’s promise to get “government off our backs” which appealed to baby boomers?). He also plans reductions in corporate taxes and heavy infrastructure spending. There are a number of downsides inherent in Trump’s policies from the stock market viewpoint. An estimated 50 per cent of earnings made by US stocks are generated abroad and trade wars are not good for them. As one billionaire Republican pointed out…“We export planes and software and import fruit and vegetables”.

Any changes to personal and corporate taxes will take some time to have an impact (2018 or later). Importantly the political dimension could hamper the plans. Republicans are opposed to increasing the deficit and have spent the past eight years trying to stymie many of Obama’s expenditure plans.  Also on the downside, travel bans on Muslim migrant workers are being opposed by Silicon Valley while price controls on pharma companies could hurt them also. Investors should take opportunities to reduce their exposure.