The only question that matters for investors on Trump’s inauguration day

By John Stepek

published 20 January 2017

in Features

170120-trump-b — For investors, it's irrelevant how "business friendly" Trump is

It's Donald Trump's big day.

Every day, of course, is Trump's big day.Each day is bigly-er and better-er than the last.

And so it will carry on for the duration of his presidency. And America will be bigly-er and better-er too.

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But what will it all be like for investors?

For the answer to that, we need only ask one question...

Stockmarket returns under the last three presidents

America is currently in the unusual position of having had three presidents in a row who each served two four-year terms. (The last time this happened apparently was when James Monroe, the fifth president, stepped down in 1825. His successor, John Quincy Adams, lasted for one term.)

Of the last three presidents, the stock market did best under Bill Clinton, extremely well under Barack Obama, and worst under George W Bush.

How much did this have to do with the presidents in question? Very little, of course.Instead, it had a lot more to do with how expensive stocks were when they took over.

We've talked about Robert Shiller's cyclically-adjusted price/earnings (Cape) ratio many times before in Money Morning and in MoneyWeek. The Cape looks at the price of a market, divided by its earnings.

When the Cape is low, a market is cheap you aren't paying much for each £1 or $1 of earnings. When the Cape is high, the market is expensive you are paying a lot for each £1 or $1 of earnings. So it's just like a standard p/e ratio.

However, the Cape improves on the ordinary p/e ratio, because it takes an average of earnings over a number of years, rather than just one year. The idea is to "smooth" earnings out over a business cycle.

So it irons out the ups and downs in earnings that cyclical stocks in particular will face as the economy accelerates and slows. That in turn, should mean you get a much better view ofhow expensive or cheap a given Cape is relative to its history.

When Clinton took office, stocks weren't cheap. The Cape was at 21 on the high side. However, they were about to enjoy an epic run-up to unheard-of heights of overvaluation during the dotcom bubble. The S&P 500 trebled during his term in office, even although the tech bust was well underway by the time he left.

Bush took over in the middle of the tech bubble bursting. US stocks at that point were incredibly expensive the market was trading on a cyclically-adjusted price/earnings(Cape) ratio of 37. Bush then left just as the credit bubble was in the middle of bursting. That's two epic bubbles and busts in short order. So it's little wonder that during his time in office, the S&P 500 fell by 40%.

And then of course, Obama took over at the start of 2009. The Cape was 15. The market bottomed out a few months later as the money-printing kicked in, and stocks haven't really looked back since. The S&P 500 hasn't done quite as well as it did under Clinton, but there's really not much in it.

The big question toask on inauguration day

The Asian financial crisis. The rise of China. The Russian default. The introduction of the euro. September 11th 2001. Enron. Worldcom. The second Gulf War. The European financial crisis.And that's just the edited highlights.

If I asked a random sample of Money Morning readers to rank those three specific presidents in terms of competence, I reckon I'd get a pretty wide range of answers. (And I don't feel particularly qualified to comment if I'm honest I've noticed that the things that matter to a foreigner in another country's leaders, are usually very different to the things that matter for the domestic voter.)

What's my point? Everyone had different hopes and dreams for each of these presidents. They all succeeded or failed to a degree that largely depends on your point of view and personal politics. And while each of them was in power, a great deal of "stuff" happened.

But for an investor, only one question really mattered on each president's inauguration day.

It wasn't:"Is this guy business friendly?"

It wasn't: "Is this guy going to get on with the current Federal Reserve chairman?"

It wasn't: "Is this guy going to tackle the deficit?"

The only question that mattered was: "Is this market cheap or not?"

Everyone seems to be hoping that Donald Trump is Ronald Reagan. An ex-entertainer and Washington outsider, written off as a buffoonish embarrassment to the office, who turns out to be a good president.

And maybe he is.

But when Ronald Reagan took office in 1981, US stocks were dirt cheap, sitting on a cyclically-adjusted price/earnings ratio of just nine. The market doubled while he was in office (although it didn't reach its nadir until mid-1982).

Now, as Trump takes office, US stocks are not dirt cheap. They're expensive. They're on a Cape ratio of 28 or so. That's more expensive than at any point except in the run-up to the massive bubbles of the past.

There may be a day when a buying opportunity arises but it is not this day

And of course, just because stocks aren't a "buy" on inauguration day, doesn't mean they won't ever be a buy while Trump is in charge. There were some great buying opportunities during Bush's time in power, for example. 2003, the bottom of the tech bust, was a good one.

The market might be expensive today, but it won't necessarily stay expensive. With any luck we could get a post-Trump bout of irrational exuberance followed by a big bust and a cracking buying opportunity.

Jeremy Grantham of GMO, as I noted last week, is less optimistic, reckoning that with Trump we get a whimper rather than a bang no "proper" bubble and no "proper" bust, just continued attrition.

We'll see. Anyway, my point is don't get distracted by all the hopes and fears and fake news swirling around the Trump presidency. As an investor, facts really are your friends.

And the objective facts demonstrate that today at least US stocks are expensive.

(Don't be gloomy though there are plenty of other things you can buy. I just chaired the latest MoneyWeek roundtable last night and there were some cracking tips. We'll have them all written up for you in next week's issue. If you're not already a subscriber, why not sign up now?)

John Stepek is a senior reporter at Bloomberg News and a former editor of MoneyWeek magazine. He graduated from Strathclyde University with a degree in psychology in 1996 and has always been fascinated by the gap between the way the market works in theory and the way it works in practice, and by how our deep-rooted instincts work against our best interests as investors.

He started out in journalism by writing articles about the specific business challenges facing family firms. In 2003, he took a job on the finance desk of Teletext, where he spent two years covering the markets and breaking financial news.

His work has been published in Families in Business, Shares magazine, Spear's Magazine, The Sunday Times, and The Spectator among others. He has also appeared as an expert commentator on BBC Radio 4's Today programme, BBC Radio Scotland, Newsnight, Daily Politics and Bloomberg. His first book, on contrarian investing, The Sceptical Investor, was released in March 2019. You can follow John on Twitter at @john_stepek.