Olivier Blanchard (PIIE), Christopher G. Collins (Federal Reserve Board of Governors), Mohammad R. Jahan-Parvar (Federal Reserve Board of Governors), Thomas Pellet (PIIE) and Beth Anne Wilson (Federal Reserve Board of Governors)
Immediately following the US presidential election in November 2016, many economists were concerned that increased uncertainty over economic policy would lead to a decline in the US stock market. From the time of the election to the end of 2017, however, the stock market, as measured by the Standard and Poor's (S&P) 500 index, increased by about 25 percent. Price swings since then have led investors and economists to increasingly ask: Was the stock market rise justified by an increase in actual and expected future dividends, or did it reflect unhealthy price developments, which may reverse in the future?
This Policy Brief examines the movement of stock market prices from the time of the election to the end of 2017. It concludes that a bit more than one half of the run-up in the S&P 500 can be explained by an increase in actual and expected dividends. The effects of the perceived probability that a corporate tax cut bill would pass Congress account for 2 to 6 percentage points of this increase. The rest can be attributed to a decrease of less than 100 basis points in the equity premium, a decrease that leaves it roughly equal to where it was in the mid-2000s.