The bullish post-election Trump trade has carried all the major U.S. stock market measures to new highs.
Many investors who got left behind by the sudden surge in stocks are now scratching their heads wondering if they should hop aboard this speeding freight train before it gets any further down the tracks.
Others are convinced the rally is simply a knee-jerk reaction that may soon get derailed. Who’s right, who’s wrong and what’s at stake?
The week prior to Election Day, the Dow Jones Industrial Average closed at 17,888. Since then it’s been on a rocket ride to the upside, gaining 18 of the last 22 trading sessions while racking up gains of 9.3%. The small-cap Russell 2000 Index has performed even better, up 18.2% over the same stretch. Wow!
Is this upside surge in stocks sustainable? Historically speaking, the answer is yes.
Gains like these in such a short time frame indicate a lasting uptrend is in place, but not without short-term pullbacks along the way.
There are several fundamental factors that support higher stock prices ahead …
#1: Market Breadth: Was weak heading into the election with too many stocks languishing below their 50-day price moving average. That’s the definition of a stock trending down, and it’s bearish for the overall market.
But since Election Day, we’ve seen many more stocks participating in the rally.
Nearly 70% of stocks in the S&P 500 are now trending above their 50-day moving averages, a bullish turnaround. Plus, the number of stocks hitting new 52-week highs has expanded too; another positive.
#2: Credit Markets: When stocks sold off in mid-2015 and again to start this year, rising credit-market stress was a big bearish factor.
Recall last year, the worry was that over-leveraged energy stocks would default in droves as oil prices plunged. Early this year, investors feared that credit stress was spreading to other sectors, including healthcare and industrials.
But take a look at the chart above. This is the Merrill Lynch U.S. High Yield Bond Index. You can clearly see how this key measure of credit stress led stocks down in 2015, which continued early this year.
The index bottomed in February, about the same time oil prices did. Since then, high-yield bonds have rallied all the way back to new highs, indicating no more worries about spreading credit stress.
Trump’s promise to cut corporate taxes could sustain the rally in high-yield bonds, but keep a watchful eye on this index. If it rolls over again from recent highs, stocks could easily follow to the downside.
#3: Bullish Seasonality: Finally, stocks are now in the sweet spot in terms of seasonal trends. The best six-month period for stocks started in November and runs through next April, as you can see in the chart below.
On average, stocks gain 1.4% in the month of December alone (up 74% of the time) and another 1%-plus in January. In spite of minor pullback potential in February, stocks are in the midst of a very favorable period for more gains in coming months.
Bottom line: The recent breakout to new highs in multiple indexes, supported by these bullish factors, tells me this rally could sustain itself well into 2017. But the market is clearly overbought after this straight-up Trump rally and a correction is likely at some point.
Consider this: The S&P 500 experienced a very similar bullish breakout with a rapid run to new highs early in 2012. But then stocks peaked in April 2012 and suffered a correction of 11% before rebounding to new highs.
Late that year, stocks slipped again, falling about 9%, before ultimately notching a series of new highs that saw the S&P 500 climb 30% in 2013.
A similar pullback this time around, perhaps closer to Inauguration Day, could be a terrific buying opportunity for those who missed the first leg of the Trump express to the upside.
Director of Research