No one usually looks to Venezuela for investment advice, but here’s one thing the South American country can teach us.
The so-called Trump Effect on the stock market has become a common water cooler topic since Donald Trump’s inauguration. Generally, people on the Right (as well as Mr. Trump himself) view the Dow Jones’ surge as a vindication of his economic policies. Regressing stock market performance with political events has been a tactic used by both parties to their advantage, but economists have yet to agree on any direct causal links between short-term policy expectations and market performance.
Venezuela’s premier stock exchange, Caracas Stock Exchange, was the world’s best performing stock market last year. Anyone familiar with Venezuela’s economic troubles might be stunned to hear that the stock market of a country run by an old-school socialist regime gained 114 percent in 2016. The Dow recorded a gain of 13 percent for the same period.
The curious case of the Venezuelan public equities market is a prime example of why it can be misleading to use stock markets as indicators of economic performance. Most economists agree that Venezuela’s economy is in turmoil, and that there is no end in sight. The real reason behind the market’s astronomical rise has little to do with ebullient investor sentiment, but instead is one of the symptoms of the government’s inflationary monetary policy. In short, owners of the country’s currency protected themselves from the currency’s severe devaluation by exchanging their bolivars for seemingly safer assets, including stocks. With huge volumes of money pouring in, the stock market artificially inflated.
But Venezuela’s irrational stock market is no exception. History has demonstrated that in the United States, markets can reach sky-high levels even when key economic indicators, such as unemployment and corporate profits, suggest otherwise. Many wise men have pondered on why these market distortions occur, but have arrived with few helpful answers except that people are irrational.
The bottom line is that the Dow and S&P 500 can accurately portray economic realities, but not all the time. The market capitalization of a stock exchange is dependent on a myriad of factors, which makes drawing definitive conclusions difficult, if not impossible.
As legendary investor Ben Graham said, “hindsight is always 20/20,”—especially when discussing the Trump Effect at the water cooler.