Why you shouldn’t get caught up in the post-election stock-market frenzy: Morningstar
Investors had a field day on Wednesday, plowing money into the stock market following the news that former president Donald Trump had won a second term. The S&P 500 rose 2.5%, while the Dow Jones Industrial Average ended the day up a whopping 3.5%.
But even as prices soar, it’s important not to get caught up in the mania beyond your normal risk tolerance, warns Morningstar Senior US Market Strategist Dave Sekera.
“Don’t let any of these dire headlines that you may see here in the short term dissuade you from your long-term investment objectives,” Sekera said in a webinar on Wednesday morning.
“Based on your risk tolerance, I probably wouldn’t be making any changes here today,” he continued. “And when you do make changes, make sure that you’re only making changes when there’s really a change in your underlying fundamentals and only make changes in your portfolio based on an informed analysis.”
While not letting near-term developments derail your plan for your portfolio is classic advice, Sekera said there’s another reason to be extra cautious: stock valuations are at some of their most expensive levels in the last decade-and-a-half.
“When I look at the market today, it is trading, with today’s bump, probably a 3% to 4% premium above fair value,” he said. “Now, a lot of investors may say, ‘Eh, 3% to 4% doesn’t sound like that much from a market point of view,’ but when I look at our valuations going back to 2010, less than 20% of the time have we seen the market trade at this much of a premium or more.”
While Morningstar has its own proprietary valuation measures, common metrics show the S&P 500 is indeed expensive. Below is the Shiller cyclically-adjusted price-to-earnings ratio, for example. It’s a 10-year rolling average of the market’s trailing 12-month PE ratio.
These valuation levels have prompted some top investment banks, including Goldman Sachs, to warn of relatively poor returns in the coming decade.
At the same time, investors are probably right to be excited about the prospect of lower taxes and regulation, Sekera said. Even what some investors may view as negatives, like tariffs and the potential inflation that could result from them, may end up being a boon for stocks, he said.
“From the stock point of view, for those companies that have pricing power, that actually could end up helping them generate some additional earnings growth,” he said.
If Republicans end up taking a majority in the House of Representatives alongside their victory in the Senate and the White House, bullishness around more tax cuts may especially be well founded, according to Sekera.
Still, markets are unpredictable, and investors shouldn’t overreact to events like elections, as there are many variables at play beyond who is in political power — like starting valuations. Sekera pointed to a recent article from his colleague John Rekenthaler, where he highlighted that oil stocks have done much better under President Joe Biden than they did during Trump’s first term, despite their differing attitudes toward the fossil fuel industry.
That’s again why Sekera is urging restraint, with the market being expensive. That is particularly true for growth stocks, which trade at a “very large premium,” he said.
Value stocks and small-caps are where Sekera sees the most opportunity — especially in the latter.
“The small-cap space, even with today’s bump, it’s still the most undervalued part of the market in our view,” he said.