My Forecast: Post-Election Correction Now...Big Gains Later

There’s quite a lot going on in the Washington political scene, with clarity harder to find right now. That’s why stocks have been somewhat indecisive about which direction ultimately prevails since the president’s inauguration.

The upshot of that is that we haven’t had a full, blown-out decline. Instead, funds are staying within the market, and just moving from one sector or asset class to another.

So where do I think we’re heading next? First, it’s normal to see equity market corrections after inauguration day. Markets typically rally on hope after an election, then give some of that ground back once the new president takes the helm with his team.

Looking at post-election years going back to 1950, stocks were down 1.8% on average one month after the president took office, regardless of which party took control. As you can see in this table, markets were down 3.85% for Reagan and 4.37% for Obama:

It stems from hope being replaced by the reality of the political obstacles facing a new administration – a “buy the rumor, sell the news” type of situation. But that doesn’t mean the outlook is bleak. It’s just a lesson in the psychology of markets more than anything else.

To circle back to our Reagan and Obama examples, stock markets rallied 113.2% during the eight years Reagan was in office, and 112.7% during Obama’s two terms. Panicking after the initial decline could have left you on the outside looking in during those epic rallies.

This time around, the S&P 500 closed at 2,271.31 on Trump’s inauguration day, then spent some time chopping around. While we’ve managed to gain some ground since then, we’re still not too far from that level now. That‘s pretty impressive given the confusion over what’s going on with Twitter, protests, immigration policy, and more.

Now, let’s talk about the outlook for small cap stocks. Despite the Dow remaining in the vicinity of its 20,000 milestone, small caps are showing a bit of relative weakness versus the S&P 500 recently:

But that’s to be expected considering small caps were the stocks that rallied the most post-election. For now, the pause in January and earlier this month look like nothing more than perfectly healthy pullbacks, and no reason to believe we are in the midst of a larger correction.

Policy measures that foster growth and deregulation would be welcome, and could be the next catalyst these seemingly starved markets are waiting for. After all, we’re coming off the ”drip” of monetary policy stimulus, and aching for something else to take its place – i.e. fiscal policy.

Any mention of that in the near term could prompt small caps to regain their relative performance footing vis-à-vis larger cap stocks. I believe that will happen sooner rather than later. Longer term we’re still on solid footing, and any supportive policy could be the icing this market is looking for on top of its cake.

Best wishes,

Mandeep

Small Cap Edition, By Mandeep Rai, Senior Analyst Mandeep Rai has more than 15 years of investing experience, working as both a stock and credit analyst. At Weiss Ratings, he researches and evaluates financial and economic themes, and makes decisions on when to buy or sell specific shares for the Top Stocks Under $10 portfolio.