Download now: How To Invest in the Coming Bitcoin Boom

Is the Trump Rally Done?

Written by Briton Ryle
Posted December 21, 2016 at 6:05PM

With Christmas just four days away, it looks like the Santa Claus rally will take us to Dow 20,000 in the next few days. Yeah, the financial media loves to get all worked up about big, round numbers that have no significance except for being big, round numbers.

In other words, Dow 20K doesn't *mean* anything. It's not a reversal point, it's not a breakout point. It's just a point on a chart, no different than 19,999 or 20,001. 

Before the election, I talked a lot about biotech stocks — especially Gilead Sciences (NASDAQ: GILD) — as a market barometer.

Drug pricing had become a political issue. And when you see stocks rally under a cloud of concern, it's a sign that potential bad news is priced in. This is known as climbing the Wall of Worry. When biotech was showing some relative strength ahead of the election, I thought it meant that investors weren't worried about how the election would affect stocks, and the market was ready to rally. On November 7, I wrote: 

I've told you about my election barometer Gilead Sciences (NASDAQ: GILD). It's been pretty strong, despite the overall market. I think it's signaling that we've got a rally coming up. And given the strength of earnings, it could be a pretty good rally.

Nice call, right? Well, I will thank you in advance for ignoring the fact that the election result itself was a complete surprise to me, and pretty much everyone else, including Trump. So I was right about the rally, for all the wrong reasons. 

But that's how it works. Buyers and sellers seek out news or a catalyst for what they were going to do anyway. That's an important thing to know. News itself is usually secondary. 

Like, remember the Greek debt crisis? Greece had been a financial disaster for a few years. A lot of people knew it. So why did it emerge as a major catalyst for stocks when it did? 

Follow the Road, But Read the Signs

I've said before that stocks will rally when they have a window to do so. It's a sentiment thing. Right now we have one of those sentiment windows wide open, and stocks are rallying. That IS going to change. It's inevitable.

But knowing that doesn't mean it's going to happen right now. Bearish investors will say, "Look, Amazon has a P/E of 176, it's going down." It just doesn't work like that. 

The current rally is based on hope. Investors are pricing in what they *hope* Trump will do. Is it reasonable? Sure. Is it likely? Yeah, I think some things, like a lower corporate tax rate, are likely to happen. Is that a guarantee? No, no it's not...

So, why don't we get ourselves a new barometer for the Trump rally

That barometer is Bank of America. BofA was one of the big winners of the election. It ran from $17 to $23 in pretty much a straight line. I'm sure investors are expecting it to pull back, along with the market in general. But that's not necessarily what's going to happen...

Do you know what book value is for Bank if America? It's about $24 a share. BofA still trades below that. For comparison's sake, JP Morgan trades at about 1.3 times book, a 35% premium. (This is a big reason why I've been relentlessly bullish on BofA in my Wealth Advisory newsletter, and I've recommended the stock here in Wealth Daily several times, too.)

So, despite that rally, Bank of America is not expensive. You could even argue that it is actually cheap. So, sure, it's got to take a break from rallying at some point. But that doesn't mean it is going to sell off. And it certainly means you shouldn't bet on a decline right now, not until you see some signs that selling is actually happening.

Tops are a Process

The S&P 500 is in a similar situation. Right now, the forward P/E based on my expectation for 2017 earnings per share (EPS) of $134 is a little below 17. That's not outrageous.

(Now, so you know, most Wall Street 2017 earnings estimates range between $129 and $140, but they don't include the benefit of a lower corporate tax rate. Estimates are that a 20% tax rate would boost earnings by $8–$12 a share. So my earnings estimate, which assumes a lower rate, is actually kind of low.)  

And there could be upside to the EPS, to maybe $140. $7 more in earnings might be worth 100 points on the S&P 500. And if investors get excited that the U.S. economy is moving beyond the New Normal (the ~2% growth that we really haven't enjoyed very much at all for the last eight years), well, the S&P 500 has even more upside. 

Now, please understand, this is not a forecast. A lot has to go right for the S&P 500 to hit that $134 number. Like a corporate tax cut. Without the rate dropping to ~20%, there's no way we see $134 in per-share earnings next year. My point here is simply to show you there is an upside story. 

I know some people will say you can't properly value this market because of the Fed and QE. And there is some validity to this. But, two things: One, you can't invest in the market you want — you get the one you get, might as well make the best of it. And also, when has the market been perfect? Pretty much never. Though I will say it was easy to be super bullish in 2010–2012. 

And two, the Fed has forecast three rate hikes in 2017. That puts the Fed funds rate at 1.5%. Not high. Not close to high. Investors were fine with this forecast, so I am not overly concerned that the Fed is a threat. If you want to talk about a threat, talk about the U.S. dollar...

It's often said that bottoms are V-shaped, tops are a process. If you remember March 10, 2009, you know what I mean about bottoms. Stocks were getting creamed relentlessly, day after day. Then one day, banks rallied, and that was it. Off to the races.

Market tops usually don't work like that. When the market peaks, it tends to turn flat first. The S&P 500 will go sideways for days or weeks before it really heads lower. 

And don't worry, we'll talk about it...

Until next time,

brit''s sig

Briton Ryle

follow basic@BritonRyle on Twitter

An 18-year veteran of the newsletter business, Briton Ryle is the editor of The Wealth Advisory income stock newsletter, with a focus on top-quality dividend growth stocks and REITs. Briton also manages the Real Income Trader advisory service, where his readers take regular cash payouts using a low-risk covered call option strategy. He also contributes a weekly column to the Wealth Daily e-letter. To learn more about Briton, click here.

Comments

Buffett's Envy: 50% Annual Returns, Guaranteed