Post-Election Stock Market Rise Not a Bubble: Study

After the election of Donald Trump, many economists predicted that increased uncertainty over economic policy would lead to a decline in the US stock market.

Yet the exact opposite occurred.

Since the election, the stock market has risen continuously — until the most recent volatility. The S&P 500 Index climbed dramatically, increasing by 25 percent during the period November 2016 through the end of 2017.

Although the post-election increase belied the predictions, heightened volatility since January has led investors as well as economists to question whether the rise in the market was due to an increase in actual and projected dividends, a historically significant factor in determining the price of equities.

Or, did the rise contain any attributes of stock market bubbles that could portend a reversal of fortune in the future?

A recent study by the Peterson Institute for International Economics concluded that the main factors behind the stock market increase were a general improvement in economic activity and a decrease in economic policy uncertainty around the world, not bubble thinking.

Not only did the U.S. stock market increase in value, but world economic activity was stronger than anticipated, leading to a concomitant rise in markets around the world.

The study examined the MSCI World Index and noted that it had increased by 21.4 percent from the time of the election to the end of 2017, nearly as much as the S&P 500 index.

“These facts make it clear that good news on domestic and international activity was an important factor in the recent rise of U.S. stock prices,” the study’s authors observed.

Tax law impact

The study also examined a number of factors, including recent tax law changes in the United States and dividends and concluded that, “a bit more than half of the increase in the aggregate U.S. stock prices from the presidential election to the end of 2017 can be attributed to higher actual and expected dividends.”

The changes in US corporate tax policy was another factor that had a favorable impact on the rise of the market.

“Together, these two numbers suggest that the new tax law will generate an increase in after-tax earnings given pre-tax earnings of about 4 percent of pre-tax earnings; thus, the overall effective corporate tax rate on S&P 500 firms should decrease from about 25 percent to about 21 percent,” the study said.

The change in economic forecasts after the election were real, the authors concluded.

“For the United States, the revisions to the economic forecasts for 2017 and 2018 were substantial: up for real GDP and corporate profits, down for inflation,” the wrote.