Election Aftermath

What consensus had expected to be a photo finish appears to have resulted in a clear win for former President Donald Trump for a second term. To find a situation where a president recaptured the White House after losing it, one would have to go back to President Grover Cleveland’s victory in 1892. Various outlets indicate the Senate has turned over to the Republicans, as widely expected; however, the margin of victory was wider than most anticipated, albeit less than 60 seats. It is too early to tell who will win control of the House. 

The market’s initial reaction to the election outcome has been an upside price shock. With many investors braced for a prolonged period of uncertainty, simply gaining some clarity on the outcome is providing a sigh of relief.

Moreover, areas perceived to be leveraged positively to a Trump presidency—which the consensus sees bringing a potentially stronger economy and easing regulatory backdrop—are seeing the greatest upside moves.

Indeed, early indications show small caps and financials jumping more than 5%. The 10-year U.S. Treasury yield is up 15 basis points (0.15%), partly on the potential of stronger growth, but also the potential of higher deficits and inflation. Higher interest rates are also supporting a rise in the U.S. dollar of 1.4%. Conversely, areas where Trump’s policies are perceived to be less friendly and potentially subject to greater tariffs, such as Mexico and China, are lagging.

The market currently appears more focused on the positive aspects of Trump’s agenda with less emphasis on the potential of tariffs and wider policy outcomes.

Our Take

Zooming out, historically, markets have done well under a wide range of Washington configurations, including the most likely outcome of this election.

Coming into today, the S&P 500 has already seen the strongest market return for any election year through October since at least the 1950s.

The sharp market response today makes sense insofar as investors came into the presidential race expecting it to be closer to 50%-50%. Now the market is reacting more forcefully as the outcome becomes clearer and more tilted than consensus expectations.

If today’s indications on the election hold, some of the knee-jerk reaction will likely carry on a bit further, even though investors should be braced for wide swings in the weeks ahead.

Still, the S&P 500 has been higher by year end in 19 out of 20 times when the S&P 500 was up more than 15% through October.

Comparing the environment to the 2016 election

As a reference, in 2016, which arguably was a bigger election surprise when Trump won the presidency, interest rates continued to rise alongside equity markets after the election. Small caps rose by about 15% and outperformed large caps by about 10% over roughly the next month after the election as the 10-year U.S. Treasury yield rose by about 60 basis points (0.60%).

Still, the backdrop remains complex. There are some notable differences compared to 2016. Deficits are already much larger than they were in 2016, and a potential rebound in bond yields is likely to constrain the magnitude of any tax cuts—though much of the 2017 Tax Cuts and Jobs Act, such as the lower capital gains taxes, are likely to be extended.

Notably, the 10-year U.S. Treasury yield was below 2% back in 2016 versus above 4% today. Corporate tax rates were reduced from 35% to 21% back then; thus, there is less scope for dramatic reductions. 

The market is still pricing in a 95% chance of the Federal Reserve (Fed) cutting rates later this week; however, the Fed may go slower than they would have prior to this result. Recall, in 2018, after the tax plan was implemented, the S&P 500 was flat as the Fed responded to stronger growth and inflation with higher short-term rates.

Our major investment themes largely intact

The weight of the evidence suggests the primary market trends remain positive. There will be periodic pullbacks and valuations are certainly on the rich side. Yet, pillars of this market also remain intact: 1) Don’t fight the trend, and 2) Don’t fight the Fed, in addition to corporate profits that continue to surprise to the upside.

From a global asset allocation standpoint, we maintain an equity bias and a preference toward the U.S. over international markets.

The U.S. continues to lead in innovation and earnings, built on the foundation of resilient and inclusive institutions, as aptly described in a recent publication by our senior investment strategy analyst, Eylem Senyuz.

We still have an emphasis on large caps over small caps, even though on a shorter-term basis, small caps are likely to outperform. Small caps have underperformed by a wide margin this year, and there is a catch-up opportunity headed into year end. On a longer-term basis, the asset class remains in a tug of war between a resilient economy and higher interest rates.

From a sector level, we still have a favorable view of financials based on a resilient economy and firm credit markets, which are also getting a lift today on the Trump victory. We maintain our attractive view of technology, given strong profit trends and aided by a positive outlook on Artificial Intelligence (AI). Finally, we still hold a favorable view of utilities, partially as a derivative of AI and increased power consumption, though it will likely underperform near term based on higher rates.

We expect this election outcome will result in greater interest rate volatility. Our fixed income team sees the 10-year U.S. Treasury yield now trading at the upper end of fair value. That said, there is the potential for a short-term overshoot, and our team will be monitoring yields closely for an opportunity to extend maturity (duration).

We retain a favorable view of gold, given the potential for greater deficits and inflation.

Bottom Line

Elections matter. And for today, it may seem like the election is the only thing that matters. Yet our work strongly suggests over time other factors, in aggregate, tend to matter more, such as the business cycle and corporate profits. Still, simply gaining clarity is providing the market a sigh of relief. Stocks tend to add to gains after being up for the year.

Markets are pricing in most of the positives today, though the backdrop is complex, and rates, deficit concerns, the potential for fewer Fed rate cuts, and tariffs could eventually provide a counterbalance to today’s upside price shock.

Still, the weight of the evidence in our work indicates the bull market still has some longevity left, and we are sticking with the primary market uptrend.