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Why has the stock market risen so much since the election?

Why has the stock market risen so much since the election?. AEA meetings January 2018 Olivier Blanchard. An increase in the S&P index of 23% (87% since 2010). Prices, earnings, and dividends. So an increase in P/E of 12% since the election (despite an increase in R).

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Why has the stock market risen so much since the election?

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  1. Why has the stock market risen so much since the election? AEA meetings January 2018 Olivier Blanchard

  2. An increase in the S&P index of 23% (87% since 2010)

  3. Prices, earnings, and dividends • So an increase in P/E of 12% since the election (despite an increase in R). • Increase in expected earnings? Good news about the economy (pre-tax earnings), or/and good news about tax reform (after-tax earnings)? • Or: • Decrease in the equity premium? (Lower perceived risk, decreased market risk aversion, or, alternatively, bubble interpretation)

  4. Good (cyclical) economic news, especially in Europe Relevance of non-US developments. Share of sales in foreign countries: 50% Source: SPF from Philadelphia FED, ECB. Forecasts as of 2016-4 and 2017-4.

  5. Expected earnings or equity premium? Two measures of the equity premium: • Simplest: X = E/P – R, with R given by 10-year inflation-indexed rate. (Importance of R) • Gordon’s formula: X = D/P + expected g_D – R, with g_D forecast from regression of realized 10-year dividend growth on E/P and D/P Decrease in X of .98% or .70%. Substantial, but back to first half of the 2000s. Could we be underestimating g_D, given tax reform?

  6. Stock prices, and tax reform • General tax reduction: Higher demand, higher growth, higher interest rate. Net effect depends on Fed reaction function. Ambiguous. • Corporate tax reduction: Higher after-tax earnings given before tax-earnings. Likely to be the dominant effect for stock prices • A simple computation (based on house version, as in JCT, JX65-17) • Stock price as EPDV of after tax dividends • Decrease in effective tax rate on C corporations: 19% of itself (25%), 4.8% of profits • Static expectations: 4.8% increase in stock prices • Forward looking (Q model, with costs of adjustment): closer to 3%

  7. Going deeper. Probability of tax reforms over the year: Based on betting prices, Predict.it. So, high at the start, steadily declining until November, then sharply increasing. Can we find an effect on stock prices? (Will not do the job alone. The market went steadily up.)

  8. US Stock price changes, world stock prices, and changes in probability of tax reform Need to control for non-tax developments: MSCI ex US. Very significant. Larger for Russell (more small firms). If prob from 0 to 1: increase of 3.5-6%. Still implies a small decrease in the equity premium

  9. (Diff in diff.) High tax minus low tax portfolios

  10. Why has the equity premium decreased? • Economic policy uncertainty in the US? EPU News index increased from 108 to 254 from October to November 2016, then declined steadily to 106 by November 2017. • Economic uncertainty in Europe has decreased considerably. EPU index down, from 241 in October 2016 to 205 in October 2017. (Decrease in prob. of recession and of deflation.) • US equity premium depends very much on uncertainty outside the US. • Regression, monthly, since 1990: X = -.39 + 0.029 US_EPU + 0.013 EU_EPU + residual (4.8) (5.6)

  11. Conclusions • Increase in S&P price index since election of 22.4% (as of Dec 12, 2017) • Increase in prices over increase in earnings: 12% • Increase attributable to anticipation of tax cuts: around 5% • May be additional effects from anticipation of and actual deregulation • Small decrease in the equity premium. Surprising? Worrisome? Decrease in economic uncertainty outside of the US Premium back to 2000-2005 levels Little evidence of substantial bubble component.

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