The World Didn’t Burn

Last week, the market did some expected de-risking in anticipation of two significant potential catalysts: the U.S. Presidential Elections and the FOMC meeting. As it turns out, Donald Trump won the race in an uncontested fashion and the Federal Reserve cut the overnight lending rate by another 25bps. There were no riots on the streets and no civil disobedience. The Fed remains data dependent and still on track to cut rates at least once more in the next 3 months.

With these risks removed, the previous unknown elements are now known. As a function of removal of uncertainty, risk assets rallied hard into the close of the week. We would like to point out that elections are no different from any other market risk. The critical question now becomes what impact will future policy have on earnings, inflation, interest rates and economic growth -- fundamentals concerning all investors. History tells us that for the market… it doesn’t really make a difference who’s sitting in the White House.

Historically, markets have generally fared well during past elections, with the exceptions of Bush and Nixon. George Bush entered office amid a notable market bubble in the Dot.com sector that had developed over the previous 20 years; the outcome would have likely been similar had Al Gore been elected. Richard Nixon, on the other hand, faced unfortunate timing as President, especially with the Iran oil embargo, which triggered a significant increase in inflationary pressures and led to the collapse of the "Nifty 50" market bubble.

As Invesco points out in the chart below, the total return of the S&P 500 during the last two Presidential terms (Trump and Biden) have more or less had similar outcomes. For us as investors, no matter our political leaning, staying invested makes much more sense regardless of who’s President.

Yahoo Finance points out the following stats:

“The S&P 500 has been up an average of 10.68% in the year following elections dating back to 1960. That’s right in line with the standard average return for the S&P 500 over time. It’s one of many signs that while the election could very well bring some turbulence to markets over the next few days, particularly if there isn’t a clear winner, it rarely halts the long-term trend.”

Of course, investors should be cautious of the earnings expectations that are currently priced in to equity market valuations. Historically, such levels have denoted a peak in the earnings growth cycle, which would coincide with an economic slowdown or recession. The only saving grace is that valuations are a terrible market timing indicator. This is only a factor to be aware of, at the macro level.

Markets rise as a function of two drivers:

• Higher Valuations

• Higher Earnings

What the chart below shows is that valuations for S&P 500 companies have little more room to expand. That means that the bulk of stock price gains should happen as a result of EPS growth and not Price-to-Earnings multiple growth, especially when interest rates are not that low.

Our base case scenario for 2025 projects a robust EPS growth of about 21%, which the market should track. According to our methodology, all things being equal, EPS growth determines the slope of a stock’s trading channel.

Adjusting SPY’s chart for 21% CAGR, with a price target of $672, we get a benchmark ETF that has both upside and downside in almost equal measure. The immediate levels that we are watching are $613 as resistance + year-end target (R1) and $577 as support (M-Trend). Despite the fact the we get an “Overbought” reading for SPY (96/100), the recent triggering of a positive MACD Signal crossover should translate into continued gains short-term.

There are many reasons why the market is optimistic. A Trump presidency should be pro-business, with a tax reform initiative likely involving making the Tax Cuts and Jobs Act permanent. This would remove uncertainty about future tax rates.

Potential rollbacks in areas like environmental restrictions and financial oversight should also foster economic expansion. Trump’s aggressive stance on trade (particularly toward China) would benefit domestic industries like steel and manufacturing. The actual introduction of tariffs may induce some market volatility, however. Broadly speaking, beneficiaries should be Energy, Defense and Manufacturing companies, while the Tech sector (more heavily reliant on international flows) could be hampered.

Trump’s immigration policy could have an outsized impact in the agricultural labour force, with effects yet unknown and hard to predict.

The bond market seems to think that Trump’s second term will stoke a resurgence in inflation, at least judging by last week’s knee-jerk reaction. TLT, our benchmark government treasury ETF, immediately fell -3% on November 6’th, as it became obvious Trump will win. It finished the week on a positive note, above our stop-loss level at $91

It has to be said that something about the bond market’s reaction doesn’t exactly jibe. Trump ran and won on a platform that aims to reduce inflation, not increase it. Initiatives like appointing Elon Musk to a brand new Department of Government Efficiency (D.O.G.E.), with the express purpose of reducing spending and balancing the budget don’t exactly scream “inflation”.

Furthermore, some other market reactions are at odds with a reflationary narrative. Gold, a supposed hedge against currency debasement, fell precipitously after the election. The U.S. Dollar rose. A strong dollar is deflationary as it reduces import prices.

Oil (USO), another asset strongly correlated to inflation expectations, fell around -3%. Small caps, which are highly sensitive to interest rates rose in an extremely bullish fashion, despite rising yields.

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It remains to be seen to what extent Trump’s term is truly inflationary to the point that it meaningfully changes the Fed’s course. We won’t dare make a prediction on this. Instead, we’ll focus on fundamentals and supply-demand dynamics.

Share repurchases, year-end performance chasing, and momentum will support higher prices into the end of the year. The technical side of the market is undoubtedly bullish and we are maintaining our risk asset allocations fully at the moment. There is simply no reason to be bearish at the moment. From a contrarian perspective, Market Sentiment is not yet elevated enough to pose real issues.

The market does tend to historically show some weakness in early December, as funds issue dividends or redemptions. Furthermore, there is a “fading” effect in January, through the presidential inauguration. For the moment, these are problems to discuss at a different date.

This week’s key economic event is the Inflation Report due on Wednesday, with Core Inflation (YoY) expected to come in at around 3.3%.

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