This week in the markets: US investors assess the Trump bump; the UK weighs up Rachel Reeves’s Budget; and China stimulus disappoints
After the drama comes the reckoning. The last two weeks have been busy to say the least on both sides of the Atlantic. Now investors are deciding what it all means.
The big surprise last week was just how decisive the Presidential election turned out to be. It was not just a clear win for Donald Trump, and the first bounce back victory after four years out of power since President Grover Cleveland in the 19th century. The election also delivered a likely red sweep in which the Republicans control all branches of government - the White House, Senate and House of Representatives.
That makes it much easier for Trump to push through his radical plans - from tax cuts to tariffs and immigration curbs to climate scepticism. And the markets have been busy assessing what that means for our investments.
US stocks enjoyed their best week in a year, with the S&P 500 rising by nearly 5% over five days. The US bellwether rose above 6,000 for the first time as the likely implications of a Trump victory were compounded two days later by another quarter point rate cut by the Federal Reserve.
Although there remains considerable uncertainty about what exactly four more years of Trump will deliver, the market is clear about what it expects - deregulation, lower taxes, higher inflation and real bond yields, a stronger dollar, fewer interest rate cuts, tariffs on imports, less immigration.
Big winners included smaller US stocks, which will benefit from an America First agenda, energy, financials, consumer companies and one or two company specific beneficiaries. Elon Musk’s Tesla rose by around 30%, partly on the back of expected tariffs on Chinese electric vehicle imports but more importantly on the back of Musk’s expected hot line to the President and possible role in the new administration. And let’s not forget bitcoin which has soared above $82,000 on hopes that Trump will adopt a light touch to crypto regulation.
The big question now is whether to chase the rally or assume it has been better to travel than to arrive. Key to that calculation could be the track record of single party sweeps. The two-year return following the 19 elections since 1900 which have delivered that clear-cut result has been positive 15 times. Impressive odds. That is even more than case when it’s been a Republican sweep - seven out of eight positive outcomes.
That could help offset the usual shape of the four-year Presidential cycle, which tends to see better returns in the two years running up to the election than the two years after. Average returns have been around twice as good in the second half of the cycle than the first half over the years.
The good news is that the current bull market - just over two years old since the October 2022 low - has some room to keep running if history is a guide. The average bull runs for 30 months and delivers a 90% return. We are 25 months in and have clocked up about 60%. The majority of stocks are in an uptrend and the rally is broadening out, which makes it look more sustainable.
The key measures, as ever, will be earnings and valuations. On the earnings front, the ongoing third quarter results season is bang in line with the usual template. Earnings are now running 8% above a year ago, having perked up as the season has progressed. Next year’s outlook is for more of the same.
Valuations look to be more of a challenge. At nearly 26 times historic earnings and 22.5 times expected profits, the value of the S&P 500 is heading back to the peak multiple it reached in 2021 in the post-pandemic rally. Unusually, both earnings and valuations have been rising together. That always leads to a strong market, but it is rarely sustainable for long. A 32% rise in the average valuation of the market in two years must run out of steam at some point and then it will be up to earnings to drive things forward.
One key driver of where next for shares will be what happens to bonds. The expectation of lower interest rates has been a positive for shares this year, allowing them to build on last year’s strong rally. Now the prospect of inflationary policy makes further significant monetary easing look less likely. Assuming that interest rates sit 1-1.5 percentage points above the inflation rate, it looks unlikely that US interest rates will fall much below 4% in this cycle. Last week, they dipped to between 4.5% and 4.75% so they may not have too much further to go.
Pimco, one of the world’s biggest bond fund managers, warned last week that Trump’s economic plans could lead to an overheating of the economy that could halt interest rate cuts and pose a danger for shares. ‘Be careful what you wish for’ was what Dan Ivascyn, Pimco’s chief investment officer, had to say. He warned that Trump’s potentially inflationary policies were coming at a time when the US economy already had plenty of momentum.
One measure of that momentum is the gap between the yield demanded by investors in so-called high yield corporate bonds and safe government paper. This spread has fallen to a 17 year low suggesting investors are complacent about the risks to companies.
If valuations stabilise, earnings growth settles in the single digit range and there is less impetus from rate cuts than hoped for, the market trajectory is almost bound to be lower than it has been for the past couple of years. Gains will be harder earned.
On this side of the pond, we’ve now had nearly two weeks to think about the impact of Rachel Reeves’s debut Budget. While the impact on individual investors may have been a mixed bag, companies have been counting the cost of a £25bn raid on their profits in the form of higher employer national insurance.
More than 200 bosses in the hospitality industry have written to the Chancellor warning that the NI increase could lead to ‘drastic’ job cuts and business closures. They claim that the hike disproportionately hits their businesses thanks to the drop in the threshold at which employers start to pay the tax on their employees’ earnings. Other companies with large workforces of lower earners, such as retailers M&S and Sainsbury’s have also said that the rises will add millions of pounds to their costs.
One of the ironies of a Budget designed to promote long term growth in the UK economy is that in the short term it looks like being a drag on it. Implications could be lower wages, fewer jobs and higher prices in the shops. That in turn could lead to higher inflation and so higher for longer interest rates. An early measure of the challenges facing the UK economy will be third quarter GDP figures due out on Friday. The expectation is for a 0.2% growth rate, well down on the 0.5% in the previous quarter and 0.7% in the first three months of the year.
Meanwhile, in China, the focus is on whether a fiscal package announced last week to shore up the country’s struggling economy can meet investors’ expectations. Evidence on Monday, in the form of lower shares in Hong Kong, is that the stimulus has fallen short. The Hang Seng closed 1.5% lower as investors decided they had been over-optimistic about measures to underpin China’s flagging property sector and subdued consumer confidence.
China’s sluggish economy is weighing on commodity prices, with lower iron ore and copper and a further dip in the oil price to just $73.50 a barrel for the Brent contract.
