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Monmouth professor offers explanation for significant rise in Dow Jones index

Barry McNamara
12/15/2016
Associate Professor Richard Johnston

It’s no coincidence that the Dow Jones Industrial Average has been on a strong rise since the presidential election on Nov. 8.

That’s the analysis of Richard Johnston, an associate professor in Monmouth College’s political economy and commerce department.

Entering November, the Dow Jones Industrial Average had never reached 19,000. But in the five weeks since the presidential election, the stock market index not only exceeded 19,000 points, it made a strong run at 20,000, closing within 100 points of that lofty milestone on Dec. 13.

In the first nine trading days of December, the market set eight new record highs, peaking at 19,911.

Johnston said that rise can be attributed in large part to the market’s reaction to the presidential election.

“The large gain in stock prices since the election are explained by an expectation that corporate profits will be higher with the policies President-elect Trump is proposing,” he said. “Lower tax rates for corporations and lower regulation costs are good for privates. The stocks of companies in the financial sector have outperformed, as investors expect less regulatory oversight.”

To some extent, many investors think the significant increase in government spending for infrastructure projects that Trump is expected to propose will give a boost to profits, Johnston said. If corporations repatriate money sitting outside the United States, that could increase investment, hopefully leading to higher productivity and higher wages.

Johnston explained that one way stocks are evaluated to see if current prices are attractive is to look at the ratio of stock price to earnings per share.

“’Earnings per share’ is the same as ‘profits per share,’” he said. “On average, stocks have sold at a ‘P/E’ of about 15. Today they’re selling, using investment jargon, at a multiple of about 18. That interest rates are currently still low form a historical perspective – they’ve increased since the election – and justify some premium for the market P/E.”

Can this rise in the Dow last, or is it simply a bubble on the verge of bursting, perhaps spectacularly?

“If profits do not eventually grow at the higher rate investors now expect, stock prices will eventually go down,” Johnston said.

The professor pointed out that stock prices have sometimes jumped with a new president.

“In 1928, after Herbert Hoover was elected, stock prices initially jumped,” he said. “Students of history recognize what happened next with the crash in 1929. My hope is that our elected officials do not start a trade war. The (Smoot-Hawley) Tariff Act of 1930 is a classic case of results being dramatically different than intentions.”

That act raised U.S. tariffs on more than 20,000 imported goods to record levels. Most economists view the act, and the ensuing retaliatory tariffs by America’s trading partners, as responsible for reducing American exports and imports by more than half, which many economists believe also exacerbated the impact of the Great Depression.