To say this was a week for the history books doesn’t even scratch the surface. On Monday and Tuesday, I was driving back to Canada, crossing several election battleground states. Equity markets were relatively listless, following the Halloween pullback, as traders awaited the results Tuesday evening. Polls remained tight, though with a modest leaning towards the Harris camp, though still nothing to cause positioning to shift in any significant manner. Before European markets opened, it was apparent that the “leaning” was a head fake. Trump won convincingly, creating a risk-on wave as strong as the red wave that spread across the U.S. Heading into the weekend, businesses, consumers and, market participants across the globe are going to be adjusting their expectations for the future. It will be tempting to go back in the past for guidance, but like everything about this election and returning President, this future is probably going to be quite unique.

Frontloading euphoria?

Towards the end of the summer, Ally and I were advising clients that we need not make major changes to the portfolio ahead of the election. In other words, there did not appear to be a rationale for becoming overly defensive, as economic fundamentals still looked solid, inflation was falling, and interest rates were on the move lower. We stayed fully invested on the equity side of the equation, but maintained a short-duration in bonds, alongside increased exposure to liquid alternatives to minimize capital loss should bonds start to get concerned by fiscal scenarios under either Presidential candidate.

The trump win was unambiguous and so was the Republican victory in the Senate. Hence, the pro-business policy agenda has pretty much an open road and that has been reflected in stocks. From a low just under 5700 Monday at noon, the S&P500 soared past 5900 and by Thursday afternoon was almost 5% higher around 5970. This brings the year-to-date increase to 36%, compared to a 26% gain for the TSX. The NASDAQ has performed even better, with a 6.4% jump from Monday’s low and a year-to-date lift of 40%. Yet, where some individuals saw election-induced gyrations, market volatility actually has dropped substantively. The CBOE VIX index had jumped above 23 last Thursday, which was the highest since early August, but has since dropped to 15.2 and that is just above where it retraced to back in August.

I mentioned back in August that preparing for a Trump win would involve dusting off the playbook from his previous victory in 2016. In other words, we would see a number of pro-business initiatives put in place out the gate, including tax cuts and deregulations. That would likely support equity markets in the first year, however, anti-trade policies would then follow and create the potential for a slowdown or recession in the economy two or three years out. That was the pattern in 2017 and then into 2019, but things are not necessarily as cut and dry nor predictable this time around.

In fact, no one really had a solid prediction last time around because Trump was an unknown commodity, politically speaking, and we didn’t know what to expect from his cabinet. Given the decisiveness of his victory this week, we will probably know the make-up of the cabinet fairly soon and he is no longer unknown. The Trump team also knows it has to deliver quickly on economic promises made during the campaign, so policy initiatives are going to come fast after inauguration.

This partly explains the rapid risk-on move in the market, but one needs to be careful about extrapolating into 2025. In other words, it might be a mistake to overlay the equity returns of 2017 on top of where we are today. This is because the positive influences from tax policy and regulation may have already been largely baked into the pie.

The above chart shows the S&P500 over two time periods – November 2015 to November 2017 and November 2023 to the present. In 2016, the S&P didn’t start that election year off well and even in the weeks before the November, it was slumping. From the day Trump was elected, the index went on to roughly a 25% gain over the next 12 months. As you can see, with the exception of a couple of speed bumps in the Spring and July-August, the S&P has been on a tear over the past year and is already up 36% from this time last year. As much as it would be great to see another 20% tacked on this by this time next year, the odds don’t look great.

Spoiler alert

Well, if equities have had a good run since Tuesday’s vote (in addition to other risk-on favourites like Bitcoin), the same has not held true for U.S. bonds. Coming off the net favourable reads from the U.S. economy back in September, the market was already in correction mode coming into the election. The 10yr treasury yield had backed up from a low in early September near 3.6% to around 4.2% before the vote. With the pro-growth views entrenched following the election, the 10yr pushed up to north of 4.4% - the highest it has been since early July.

This setback may seem a little odd to investors. After all, if inflation is coming down and interest rates are expected to decline, shouldn’t bond yields be falling? Indeed, the Federal Reserve decided on Thursday to cut its key rate by a quarter of a percentage point to 4.75% - in line with market expectations. The Fed acknowledged some weakening in labour market conditions, which we saw in the October payrolls report last Friday and remains confident that inflation is heading in the right direction. Still, there are other factors at play. If Trump tax policies stimulate economic activity, then this could put a floor under where inflation can go. The president-elect has promised to drastically lower gasoline prices by opening the flood gates on U.S. oil production, but even if could deliver on this, the direct impact on inflation from lower pump prices would presumably be offset by stronger demand for discretionary goods and services.

There is one more FOMC meeting before year-end (and Trump’s inauguration), and it is unclear whether we will see one more rate cut. Chair Powell was fairly guarded in his Q&A session responses to questions regarding the future path of rates and especially on how upcoming changes to fiscal policy might influence this path. Let’s just say, he didn’t have to say a thing. Most economists agree that the combination of tax and spending measures by the Trump administration will significantly increase the size of the budget deficit. Domestic and international investors are going to demand a higher premium to hold longer-dated U.S. debt if the nation’s credit quality could deteriorate under the weight of even larger deficits and increased public debt.

The situation at the start of this second Trump administration is different, in terms of the bond market, than the first rodeo. Like the S&P comparison, in the above chart, I have mapped the trajectories for the U.S. 10yr treasury yield in the period before and after Trump’s election in 2016 against where we are today. Back then, yields had dipped to around 1.4% months earlier in 2016 and rose steadily into the vote, before spiking to above 2.4% in the weeks after. Things settled out over the course of 2017, though we still ended higher than before the election.

Note, inflation fears were only started to creep in back in 2016 and the Fed had only just started to notch rates higher and continued to do so until the end of 2018. This time around, inflation has just been brought under control and the Fed is anticipated to continue cutting, yet the fiscal situation now is worse. On top of that, any additional easing by the Fed is also going to be stimulative and feed expectations of a rebound in inflation. If that cause long-term bond yields to climb back towards 5% or higher, then that could not only create an attractive off ramp for those not wanting to see high double-digit returns in stocks evaporate, but also negatively impact economic growth.

The last chapter of the old playbook, namely trade and tariffs, may be a repeat of the past and raise concerns over growth and higher prices on domestically consumed products. Before we start pricing in that risk, I would suggest that a more seasoned cabinet and circle of advisors could influence the president-elect to employ tariffs as leverage instead of lobbing them on trade partners and seeing what happens. If so, then growth challenges might be mitigated. That doesn’t mean that the next four years aren’t going to be rocky. Economists would say that the U.S. is getting close to being overdue for a recession and if monetary policy is not eased enough or in a timely enough manner, then the outlook for markets is going to be less about the new President and more about simple economic physics.

On behalf of the Pyle Wealth Advisory team, have a wonderful weekend.   

Andrew Pyle