Why forecasts for a Trump victory market collapse were so wrong

S&P 500 futures tumbled 5% as Trump headed to victory late Tuesday, but they rallied back and the index finished the next day higher. Global stocks also have recovered from initial steep declines. The S&P 500 stock index was little changed Thursday.

Before the vote, most analysts and economists predicted that a Trump victory would push investors to dump risky investments, in particular equities. They were correct for a matter of hours before markets rallied sharply.

Financial forecasters say they were basing predictions of swift declines on market reactions to Trump’s campaign statements, but the Republican has come across as less caustic since securing the White House. Their drastic predictions also were shaped by the markets’ deep drops following the UK’s vote to leave the European Union in June, a result and reaction that caught analysts off guard.

“Before the election, it seems like markets were responding to Trump the man, and after they were responding to Trump’s policies,” said Justin Wolfers, professor of economics at the University of Michigan.

Wolfers, in a piece of research with Eric Zitzewitz, professor of economics at Dartmouth College, had predicted a Trump victory would knock 12% off the S&P 500. Others also were bearish. RBC Capital Markets predicted the index would fall 10% to 12% on a Trump win. Barclays expected a 6% fall before a partial recovery by year-end. Citi researchers expected a 5% drop in the index.

The research was based on how the market had moved during the presidential debates, which polls suggested Democratic rival Hillary Clinton had won.

Market sentiment shifted during the night after the election, according to Wolfers, with markets focusing more on Trump’s promises for tax cuts and an infrastructure boom. “Even if it’s a clown in the White House, he is a clown that’s going to cut our taxes,” he said.

Some analysts cited Trump’s less combative tone in the speech he gave after Clinton conceded as a factor behind the rebound, as well as a reiteration of his promises for a fiscal boost.

“When Trump himself actually gave an acceptance speech—we talked to some investors and the view was that he was very presidential in that,” said James Bart, head of European equity strategy at Bank of America Merrill Lynch.

The rally also may have reflected relief that the election ended in an orderly fashion and with a clear concession from Clinton, without allegations of vote-rigging or serious civil unrest.

Not all forecasters had expected a crash in stocks. John Higgins, chief market economist at Capital Economics, predicted a Trump victory would inspire an initial drop in the S&P 500 before it recovered.

“People had been caught off guard with the Brexit vote, and that made a lot of people more nervous about being too heavily positioned before the vote,” Higgins added.

Some investors got their fingers burned after Brexit, when global equities initially plunged, before climbing quickly back in subsequent days.

“People were thinking, ‘Oh, if that happens again I want to get ahead of it,’” said Caroline Simmons, deputy head of the UK investment office at UBS Wealth Management.

Like Trump’s victory, the UK’s June verdict was a big surprise, with analysts overwhelmingly expecting a vote to stay in the EU.

For Brexit, though, at least some market forecasts were accurate. Analysts expected the British pound to take the brunt of a Brexit. It did and still is trading around 16% below where it traded against the dollar on the night of the vote.

Roger Hirst, who works in equity sales at Deutsche Bank, said many clients were prepared to buy on any dip in the market after a Trump win.

“Everyone thinks [the stock market] crashes down 5% and everyone’s a buyer of that 5%,” he said on Tuesday, as voters headed to the polls.

The GOP’s victories in both the Senate and House of Representatives also were a factor in the market reversal.

To be sure, equity markets still could head into a deep swoon. Some analysts believe investors are expecting too much from fiscal stimulus, arguing that even with a Republican Congress, political opposition will prevent a surge in deficit financing.

Trump “will probably find strong opposition from traditional Republicans,” said Didier Borowski, head of macroeconomics at asset management firm Amundi. “This point seems to be ignored by markets.”

—James Mackintosh contributed to this article.

Write to Mike Bird at Mike.Bird@wsj.com

This article was first published by The Wall Street Journal

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