Donald Trump's landslide victory in the election sparked a remarkable surge in stock prices and a wave of optimism. The S&P 500 surged over 4% in the nine days following the election, reaching an all-time record close of 5949 on November 14. Even after a big drop at the end of the week, the big cap index is still up over 3% since Trump clinched his win. The business press is buzzing with expectations for the Trump agenda, which includes pro-business proposals like slashing the corporate income tax and fostering energy production.
The Hidden Story Behind Trump's Victory and Market Movements
Stock Prices and the Trump Effect
After Trump's victory, stock prices saw a significant uptick. The S&P 500, a key indicator of the market, soared during this period. This surge was driven by the optimism surrounding the pro-business policies proposed by the Trump administration. However, it's important to note that this upward trend may not be sustainable in the long run. 1: The initial jump in stock prices was a result of the market's anticipation of positive changes under the Trump regime. Investors believed that these policies would lead to increased corporate profits and economic growth. This optimism translated into higher stock valuations and a bullish market sentiment. 2: But as time passed, it became clear that there were other factors at play. One of the most significant factors was the sudden rise in interest rates. This unexpected shift in interest rates sent a different message than the initial optimism and had a significant impact on the stock market.The Impact of Rising Interest Rates
The 10-year treasury bond rate, a crucial benchmark for equity valuations, saw a sharp increase. From 3.74% on October 1, it jumped to 4.47% by November 18, a stunning 73 basis point increase in just over six weeks. This rise had two components: the inflation premium and the real yield. 1: The inflation premium, which measures investors' expectations for average yearly increases in the CPI, rose from 2.19% to 2.33% since October. This indicates that investors are worried about the Fed's ability to control inflation and may lead to higher short-term interest rates. Higher inflation premiums are not good for stocks as they signal potential tightening by the central bank. 2: The real yield also increased significantly, swelling from 1.56% to 2.15% and contributing 59 points to the total 74 bps increase. The real yield is a key factor in determining equity valuations as it acts as a discount rate applied to a company's expected future earnings. A higher real yield means lower stock valuations.Stock vs. Bond Returns
At current valuations, the expected return on equities is 3.4%, while the expected real return on the 10-year treasury bond is 2.15%. This narrow margin between stocks and bonds is a cause for concern. In mid-2021, when the real rate was negative 0.3% and the S&P's PE was 24.6, stocks had a much larger cushion. 1: The bulls argue that Trump's deregulatory and tax-lowering program will boost earnings and keep the markets moving upward. But the reality is that profits have been stagnating after a bubble in 2016-2021. In the past 11 quarters, EPS has only risen 2%, trailing inflation. 2: The big question is whether the rise in the real rate is a structural shift or a temporary blip. Investors are worried about the huge budget deficits exceeding 6% of GDP. If Trump delivers on his tax-cut pledge, these deficits could worsen. This uncertainty makes it difficult to predict the future direction of interest rates and stock prices.The Uncertain Future
In conclusion, the market is facing a complex situation. The initial optimism after Trump's victory has been tempered by the rise in interest rates. The future of stock prices depends on various factors, including earnings growth, inflation, and interest rates. It's clear that the market is no longer as simple as it once was. 1: Investors need to carefully consider these factors and make informed decisions. The era of extremely low interest rates may be coming to an end, and this could have a significant impact on the stock market. 2: While it's impossible to predict the future with certainty, it's important to stay informed and adapt to changing market conditions. Only time will tell how these trends will play out and what the future holds for the stock market.