EQ: We’ve officially passed the one-year mark since President Trump was inaugurated. In this week’s Sector Watch report, you assessed how the market has performed during this period. If there’s been any turbulence during his presidency thus far, it’s certainly not shown on the stock charts. Just how good has the market been over the past year, especially when compared to previous presidents?
Stovall: The stock market’s performance under President Trump has been the third-best of first-year returns since 1929. President Trump’s 23.4% gain in his first year is behind only the 89.6% under President Franklin Roosevelt and 41.3% advance under President Obama. It is also the best performance under any Republican president. I think investors were just encouraged by the programs that he was attempting to set forth.
EQ: The market continues to march ever higher, hitting new records across the board this week. Could this add more fuel to the fire of the FOMO rally we discussed recently?
Stovall: Yes, I think it can. Investors are experiencing the fear of missing out, and what they’re doing is projecting recency. Even though we did see a more than 20% advance under President Trump’s first year in office, history says we have to be careful about what to expect in his second year in office. I think investors don’t really know where the earnings are going to, and don’t really care how much the stock market costs at this point. They just don’t want to miss the bandwagon, and as a result, it could end up being a self-fulfilling prophecy, pushing share prices ever higher.
EQ: As more capital looks to enter the market, investors may be seeking opportunities with higher upside than the broader market. Many of the major indices have already surpassed initial year-end price targets. You recently examined the prospect of moving a bit downstream to smaller cap companies. Is the current environment more favorable for this segment of the market?
Stovall: We have mentioned to investors that we thought there were greater upside potential for mid- and small-cap stocks because of the projected growth in earnings as a result of the recent tax cuts. That said, because the US dollar is experiencing a bit of weakness, and we think it should remain weak for much of this year, it does tend to benefit the multi-nationals—the larger companies that have overseas exposure.
However, like the stock market, if we have already seen a majority of the dollar’s decline very early in this new year, then maybe the benefit of the weaker dollar will tread water as it bounces along the now current lower level. So, it seems as if equities are the place to be. Yet, we have gone a record number of days without a decline of 5% or more, and I think it just implies that we should not become too complacent.
EQ: What is the upside potential for the mid- and small-cap groups, and how does it compare to the broader market?
Stovall: Well, the expectations for the S&P 500 is for 5% growth, based on $155 per share in earnings as a result of the tax cut, combined with our expectation that inflation as tracked through core CPI will remain below 2% on a year-over-year percent change basis. Using a similar metric for mid-caps, we think the index could be up 12%, and using another metric for small caps, we believe they could be up by about 15%.
So, purely on a fundamental basis, we think that there’s greater upside potential in the mid- and small-cap stocks, which have not been taken advantage of by investors. Should we end up seeing the decline in the dollar stall, and investors look for greater opportunities, they might decide to go small.
EQ: As you said, it has been a long while since we’ve experienced any pullback or correction. Considering that the small-cap group is much more volatile than its large-caps counterpart, what should investors be cognizant of when entering this group?
Stovall: Well, the first impression that investors have is that anytime large caps go down, small caps go down even faster. That’s not necessarily true. It depends on what leads the large caps lower. Take a look at the tech bubble bursting in the early 2000s. While you find that the large cap stocks were down in 2000, 2001 and 2002, both the mid- and the small-cap stocks were up in 2000. Small caps were also up in 2001, and only in 2002 did both mid- and small-cap stocks suffer a decline. So, a lot of times, it really just depends on how stretched these indices are, and not because they all have to move in lockstep.
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