If you are an investor in the stock market, you have experienced some significant gains over the past few years and especially since the recent presidential election. Trump is quick to let us know just how well everything has been going since he’s taken office:
This rally, especially since the election has been built on optimism for the future, not on current reality. The truth of our current situation is that while stocks continue to go higher in price, S&P 500 company earnings have been dropping or relatively flat since August 2014:
It doesn’t take a degree in economics to see what has happened the last 2 times prices have outrun earnings growth. Spoiler alert: there was a massive correction.
If you ask the likes of Nobel Laureate and Yale Economist Robert Shiller what he thinks of this current rally he’ll point you to his cyclically adjust Price/Earning ratio chart and tell you that “The market is way over-priced, It’s not as intellectual as people would think, or as economists would have you believe.”
We are currently well above the long term historical average P/E ratio and unless all of Trump’s promises come true and S&P 500 earnings start to kick in gear, we could be facing the next correction sooner rather than later. However, if Trump is able to deliver on his promises and earnings start to accelerate we could see the P/E ratio come down without much of a hit to prices.
For now I will take the advice of Shiller when he recommends to stay partially invested in the market and I would add that you should keep a 10-15% stop loss on your positions to avoid any sudden, catastrophic drops in prices if on any given day we learn that one or more of Trump’s promises are not going to come true.