Previous week's weekly market wrap

Election Aftermath: Key Market Implications to Watch

Key points

• The decisive U.S. election outcome cleared a source of uncertainty for the markets, with stocks posting their best ever post-election rally. Republicans have a strong mandate winning the presidency, Senate, and possibly the House. While campaign-trail pledges don't always translate into policy, there are potential market implications from the shift in the balance of power.
• The likelihood of tax cuts and deregulation may boost economic growth further, supporting corporate profits and the rally in stocks. But tariffs and debt concerns may push rates up and pressure bonds, acting as an offset. 
• The Fed cut interest rates for the second time this cycle and continues to view its policy as restrictive. However, strong growth and possibly looser fiscal policy next year may lead the Fed to move more slowly, with markets starting to price in a shallower rate-cutting cycle. 
• Fundamental conditions remain favorable. We see opportunities to broaden equity allocations and to lock in high bond yields. As the post-election landscape unfolds, it's essential to refocus on long-term fundamentals rather than reacting solely to recent political shifts.

Even with a Fed meeting on the calendar, there was little debate about what dominated headlines last week. After a long political campaign filled with twists and turns, a decisive U.S. election outcome was reached, and markets began to price in any potential policy implications that may follow. 

We believe that the market's ultimate direction will continue to be shaped by the same favorable fundamentals that have powered 50 record highs for the S&P 500 this year alone, with the latest three reached after the election¹. While campaign-trail pledges don't always translate into policy and any changes take time, there are potential implications from the shift in the balance of power. And as with most things, there are gives and takes. We'd offer the following takeaways:

A decisive election outcome clears a source of uncertainty

Contrary to expectations for a tight race and the possibility of an unclear or contested outcome, Donald Trump secured a decisive win, reclaiming the White House with Republican control of the Senate. Although the House of Representatives outcome is still pending with several races left to be called, Republicans project confidence about holding control, albeit by a slim margin if so. 

Leading into the election, equity- and bond-market volatility had been rising, following historical patterns for election years. With results now known, the election uncertainty is removed from the list of investors' worries. Volatility quickly subsided, and stocks saw their best ever post-election rally with the S&P 500 rising 2.5%¹. 

We would caution that markets tend to overact the day after the election, and it wouldn’t be surprising if some of the initial optimism fades in the coming days. However, history shows that further gains are often the norm. Since 1930 there have been 23 elections prior to the current one, with equities rising on the day after in nine instances. In all cases, the S&P 500 was higher 10 days later and remained higher three months afterward in seven cases². 

However, it's ultimately the underlying fundamentals that will dictate the path forward for markets, which is why the focus will now shift to forthcoming policy changes. 

Gives: Tax cuts and deregulation may boost growth

A big part of Trump's economic campaign promises has been the extension of the 2017 Tax Cuts and Jobs Act (TCJA) provisions, which would otherwise be sunset in 2026. In addition to extending the individual tax rates, a Republican administration could also push to cut the corporate tax rates, which, in combination with deregulation initiatives, may revive corporate spending and boost economic growth. That potential boost would come at a time when the economy is already growing at a brisk pace. This scenario would benefit domestic, cyclical and smaller-cap companies, which are the ones that popped the most following the election outcome. The financial services sector was a standout, with regional banks rising 10% under the hopes of lighter banking regulations, lower capital requirements, and an easier merger-and-acquisitions environment¹.

Takes: Inflation and debt concerns may push up rates

The flip side of any new fiscal initiatives is that they would come at a cost. The extension of the existing tax cuts alone is estimated to increase deficits by nearly $5 trillion through 2034, adding to the government debt, which currently stands at about 100% of GDP³. A further jump in debt, together with tariffs and an aggressive approach to immigration, could lead to higher inflation and higher interest rates. Of course, the threat of blanket tariffs could be a negotiating tactic, and, even if implemented, the effect may not be felt in 2025. However, given the inflationary pressures of the last three years, investors will be wary of any signs that inflation is reaccelerating. Reflecting these concerns and the potential for faster economic growth were government bonds, which were under pressure last week, with the 10-year Treasury yield spiking to a four-month high before easing after the Fed meeting¹. 

Partly overshadowed by the election, the Fed cut rates for the second time this cycle, bringing its policy rate to 4.5% - 4.75%. As highlighted in the post-meeting press conference, policymakers will not react to any campaign policy proposals until they are implemented, and Chair Powell continues to view current interest rates as restrictive. But even as the plan remains for policy rates to gradually move toward neutral, the stronger economic and inflation data in recent months suggest that there is no urgency with the pace of rate cuts. Looser fiscal policy next year may lead the Fed to move more slowly than it otherwise would. And this is now reflected in the bond market, which, after the election result, is pricing in a shallower rate-cutting cycle, projecting three additional rate cuts expected by the end of next year instead of about six expected a month ago¹. Because the gap between the fed funds rate and inflation remains wide, we think that there is scope for rates to decline further, but possibly toward 3.5% - 4.0% instead of the 3.0% - 3.5% that we previously expected. 

Positive fundamentals provide stability

At this point it is unclear how many of the campaign proposals may result in actual policy, over what time frame, and what their impact would be. But what we do have some confidence in is that the fundamental conditions that drive long-term market performance remain more favorable than hurtful. 

1. The economy has consistently defied expectations for a recession over the last two years, even expanding at an above-average pace, driven by robust consumer spending. While a moderate slowdown is likely, several indicators remain strong, including rising incomes, stable employment, healthy household finances, and improving loan growth.
2. Corporate profits are on the rise, supporting a positive outlook for stocks. S&P 500 earnings growth is projected to accelerate from 0.5% in 2023 to 9% this year and 14% in 2025¹. Though next year's estimates may be a bit optimistic, the upward trajectory can help sustain the bull market, which has now entered its third year. 
3. Interest rates have likely peaked and are gradually moving lower. The Fed is cutting rates, not in response to an economic downturn, but because of an improvement in inflation, keeping the chances of a soft landing alive. 

Market opportunities to broaden equity allocations and lock in high bond yields

In our view, the tried-and-tested message over time -- don't play politics with your portfolio -- continues to hold true. Major economic trends that were in place before the election are likely to continue, and investors may want to avoid the urge to change strategies or portfolios because of the election. U.S. companies will be able to adapt to different policies as they have done successfully in the past, and global forces will continue to exert outsized influence.

That said, the potential for tax cuts (personal and corporate) and deregulation may provide an additional tailwind to the theme of broadening market leadership, which has started to take shape since the start of the third quarter. Value-style investments and cyclical sectors, along with small- and mid-caps, have been left behind since the start of the bull market in October 2022 and have room to catch up as the rally broadens beyond tech. We would highlight our overweight on U.S. mid-cap stocks and the industrials sector as two ideas that may benefit from pro-growth policy. On the other end, trade wars, the threat of tariffs, and the potential for a stronger dollar may weigh on international developed-market equities, which we have an underweight on in our opportunistic asset-allocation guidance.

In isolation, the potential policy shifts are seemingly positive for equities but negative for bonds. A likely Republican sweep may bring fiscal concerns back to the forefront amid growing deficits and elevated debt. However, we think the recent rise in yields offers another opportunity to extend the maturity of fixed-income portfolios ahead of lower rates on cash investments. As discussed, a slower pace of Fed rate cuts is possible if inflation proves persistent, but we think that yields are currently attractive and at the high end of their potential range. Repositioning into intermediate- and long-term bonds where appropriate can help lock in the high yields for longer, as CD rates will likely continue to move lower in lockstep with the Fed's policy rate. 

The long-term view

As the post-election landscape unfolds, it's essential to refocus on long-term fundamentals rather than reacting solely to recent political shifts. History has shown that markets adapt over time, with various asset classes responding differently to changes in policy and sentiment. A well-diversified portfolio is positioned to withstand a range of potential scenarios, helping investors achieve steady progress toward their financial goals. 

Angelo Kourkafas, CFA
Investment Strategist  

^{Sources: 1. Bloomberg, 2. Morningstar, Edward Jones, 3. CBO}

Weekly market stats

^{Source: FactSet, 11/8/2024. Bonds represented by the iShares Core U.S. Aggregate Bond ETF. Past performance does not guarantee future results. *Source: Morningstar Direct, 11/10/2024.}

The week ahead

Important economic releases this week include CPI inflation and retail sales data.