Q: I'm hearing a lot about a "Trump rally" in the stock market. Is this for real, and if so, is it too late to get in?
A: The rally is certainly for real in the sense that through mid-January, the S&P 500 had gained 6.3 percent since last November's election day - a nice return for just over two months. Whether this is justified or likely to continue is another question. Also, in considering these things, keep in mind whether you are just making short-term speculative trades or whether you are investing long-term for retirement in a 401(k) plan, IRA account, or similar vehicle.
2 reasons the stock market rallied
On the plus side, there appear to be two legitimate reasons for the market to have enjoyed a bit of a rally since the election:
1. The election cleared up some uncertainty
This kind of scenario has played out many times in the past. Markets hate uncertainty, and often will rally based on having that uncertainty cleared up rather than as a result of the specific outcome. After all, in times of uncertainty people tend to delay investing. Once the uncertainty is cleared up, people can assess which investment themes look promising and move ahead with their decisions.
2. There have been some pro-investment policies proposed
Between tax cuts and infrastructure investments, there is a lot for investors to like in the proposed financial approach of the new administration. If these proposals become reality, they could have a more lasting impact than just the relief of getting the election over with.
Why investors should be wary about current market
Despite the positives, there are at least two reasons to be concerned:
1. The potential cost of policy proposals is being ignored
Higher interest rates create a headwind for investments, not to mention for mortgages and other forms of borrowing. Government spending that would increase the deficit could push interest rates higher. Meanwhile, if the recurring campaign theme of protectionism becomes reality, its impact would likely be inflationary - something else that could result in higher interest rates.
2. The rally has made an already-expensive market even pricier
The recent rally has moved the price-to-earnings ratio of the S&P 500 to nearly 23 times earnings, a relatively high level. This means that there is already a fair amount of optimism priced into the market, diminishing the prospective reward on subsequent investments.
Don't get too caught up in short-term moves
Of course, while the election cleared up some things, a great deal of uncertainty remains. If you are a short-term trader, you may be attempting to profit off of making sense of that uncertainty.
However, if you are like most people and trying to make sound investment decisions for your 401(k) or IRA, then you should be less influenced by short-term developments. The best thing in that case is to set an asset allocation that best fits your retirement time horizon, and accept that you will have to ride out some ups and downs along the way.
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