By William Watts

Election reactions often produce trends that don’t prove to be sustainable investment opportunities, notes strategist

Donald Trump’s historic election victory led to a seismic week on Wall Street, as investors reshuffled their assumptions about the economy, interest rates and international relations. But investors should be wary of getting caught up in emotionally charged market narratives that may not last.

Needless to say, the election result not only wrong-footed pollsters, who were largely looking for deadlock. It also seemed to surprise investors, even though so-called Trump trades — bets on assets expected to benefit from a Republican candidate victory — had been gaining traction since October.

Instead of “selling the fact” – market jargon for taking profits after an expected event actually occurs – investors rushed into those same trades, sending the Dow Jones Industrial Average DJIA soaring more than 1,500 points Wednesday amid a stock market rally that produced even bigger results. gains for small-cap stocks and sectors expected to benefit from the Trump administration’s policies. They also sold bonds, triggering a rise in Treasury yields BX:TMUBMUSD10Y, which move opposite to prices. Rising yields and rising stocks generally don’t go hand in hand, underscoring the euphoric nature of the mood in stocks.

So, what’s at stake? Part of the reason for this is relief at a relatively clear outcome rather than a contentious, drawn-out battle. But it was also a real storm.

“Trump’s victory worked in line with economic fundamentals,” Paul Christopher, head of global market strategy at the Wells Fargo Investment Institute, told MarketWatch.

The economy appears to be heading either toward a soft landing, in which growth slows but employment remains fairly strong, or even avoiding a “soft landing,” Christopher said. This had the same effect on the market as the Trump trade: higher bond yields and higher stock prices as investors factor in a growing economy and a stronger DXY dollar, with the U.S. resembling to the cleanest laundry in a world of dirty shirts. .

Trump’s victory has investors banking on stronger economic growth, driven in part by expectations of tax cuts and deregulation, which would cause stocks to rise. It has also sparked fears of a resurgence in inflation, leading to higher bond yields.

Trump’s trade “is going in the same direction as the prevailing trend…that’s what we saw in large quantities this week,” Christopher said.

So, what’s not to like? A sharp, sudden rise in yields can be destabilizing for stocks, not only by raising companies’ borrowing costs but also by making it harder to justify high stock valuations. This is because higher Treasury yields reduce the present value of future earnings and cash flows.

The initial, simultaneous rise in stock and bond yields shows that “people aren’t combining themes in a reasonable way,” Christopher noted.

Treasury yields then retreated, posting a weekly decline. Stocks continued to climb, with the Dow, S&P 500 SPX and Nasdaq Composite COMP posting a string of records and their biggest weekly percentage gains of 2024. The small-cap Russell 2000 RUT index, up 8, 6%, saw its biggest weekly gain since April 2020, according to Dow Jones market data.

Trump’s allies have thrown out massive numbers touting possible budget cuts. Yields have retreated from their midweek highs, but observers still have little hope of seeing major fiscal austerity measures.

“Assuming Republicans retain the House, a full extension of the expiring Trump tax cuts is likely, but perhaps only for a shorter period given already high deficits,” said Libby Cantrill, head of public policy at Pimco, in a note published Friday. “We may see efforts to slightly reduce spending, but any significant reductions will be difficult to pass through the House and will be difficult to implement through the budget reconciliation process,” which requires only 51 votes in the Senate (or 50 plus the vice-president). tiebreaker by the president), as opposed to the 60 needed to defeat the filibuster.

Meanwhile, uncertainty reigns over a host of other potential Trump policies — particularly his proposed tariffs, which economists fear will dampen growth while fueling inflation.

In this climate of uncertainty, investors should keep in mind that elections often provoke immediate reactions that do not prove to be lasting investment opportunities. In other words, “reactions are not spins,” Christopher said.

Rotations occur as underlying fundamentals change, with investors shifting their exposure to sectors or asset classes accordingly; Reactions are knee-jerk decisions that often lead investors to overpay for assets or sell them for less than their fair value.

Energy stocks, for example, surged after Trump’s 2016 victory but continued to lose ground, including before the outbreak of COVID-19, for the remainder of his term.

The new administration’s agenda and priorities should become clearer by January, Christopher added. In the meantime, the latest market trends risk going too far and too fast.

-William Watts

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  11-09-24 0600ET
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