Market Expectations in Response to a Trump Presidency
The early market reaction to the election has been staggering and investors are basically returning to the same Trump playbook from 2016: the reflation trade is back. Yields are blowing out with the curve steepening and real rates driving nearly 2/3 of the widening. The Dollar is strengthening, the VIX is crashing lower, cyclical stocks are roaring, led by financials, and the US is outperforming the rest of world. Lower priced small cap stocks are having their time, leading to a broad-based surge in the equity markets.
The obvious question is how far can this trade run? It is a tug of war between rates and economic expansion and too much too fast could see that equity optimism short-circuited. At least for now, we are experiencing a “risk on” environment with uncertainty fading, sentiment rebounding, volatility compressing, and policy expectations overtly pro-growth.
Stepping back from the political implications, we’re still left with a supportive macro backdrop of resilient growth, inflation continuing to cool back to the targeted rate, a Fed that is hyper-focused on trying to manipulate the way to a soft landing, global central banks are in the midst of a synchronized easing cycle and earnings estimates are continuing to drift higher.
The tailwinds for the US economy remain robust and it’s not too hard to see why markets are championing the results.
Expectations
Trump 2.0 should be characterized as a secular US exceptionalism, and this has its privileges, minus the ongoing deficit fears.
US growth should remain firm, which supports an overweighted allocation to US equities versus others.
The expectation is the USD will remain strong. Tariff threats will likely see those in the crosshairs move to weaken their currency to compensate.
Rates should remain firm. Rates have done much of the heavy lifting given the pre-election move and continuing into this week. The trading range on the 10 Year has shifted from 3.5% - 4.25% to something closer to 4.0% - 4.75%.
Removing the election uncertainty itself is a positive – from both a risk sentiment perspective and a business-activity backdrop. Add in tax cuts, or at least an extension of the previous cuts, and the expectation of more deregulation.
Underlying growth remains firm, although the labor market has been cooling.
Corporate America was doing well to begin with, and additional tailwinds have been added, although top-line growth has been easing, so we’ll need see how this evolves.
A risk is the Fed overshooting and keeping interest rates too high for a continued rally in equities.
We need to continue to keep an eye on inflation expectations, but so far they’ve been modestly well behaved with rates rising for good reasons.
