Few were surprised when US stocks jumped after Donald Trump’s decisive victory in the presidential election. Amid widespread assumptions of weeks of uncertainty, a clear result was always likely to prompt an initial relief rally. More unexpected was what has happened since.
The president-elect has nominated a string of hardliners to senior positions, signalling his intent to push ahead with a radical agenda to enact sweeping tariffs and deport millions of illegal immigrants that many economists warn would cause inflation and deficits to spiral upward.
Yet the stock market — the economic barometer most closely watched by the general public, and one often referenced by Trump himself — seems to have shown little sign of concern.
The S&P 500, Wall Street’s benchmark index for large stocks, is still up about 3 per cent since the vote, even after a slight pullback. The main index of small cap stocks is up almost 5 per cent.
The relative cost of borrowing for large companies has also plummeted to multi-decade lows, and speculative assets such as bitcoin have surged.
Under the surface, not every part of the stock market has been so calm. A Citi-created index of stocks that may be vulnerable to government spending cuts, for example, has tumbled 8 per cent since the election, while healthcare stocks have been hit by the nomination of vaccine sceptic Robert Kennedy Jr to head the health department.
The prospect of inflation arising from tariffs and a tighter labour market has also spooked many in the $27tn Treasury market, with some high-profile groups warning about over-exuberance.
But the contrasting signals raise some key questions for traders and policymakers alike: are equity investors setting themselves up for a fall by ignoring high valuations and potential downsides of Trumponomics, or will they be proved right as gloomy economists once again have to walk back their dire prognoses?
“Any time . . . you get to the point where markets are beyond priced to perfection, you have to be concerned about complacency”, says Sonal Desai, chief investment officer at Franklin Templeton Fixed Income.
But, she adds, “the reality is you also need to very actively look for triggers for sell-offs, and right now . . . I think the underlying economy is strong and the policies of the incoming administration are unlikely to move that significantly.”
The bull case was on full display at the Wynn resort in Las Vegas this week, where more than 800 investors, bankers and executives were gathered for Goldman Sachs’ annual conference for “innovative private companies”.
With interest rates now trending downward, capital markets specialists had already been preparing for a recovery in stock market listings and mergers and acquisitions activity, but the election result has poured fuel on the fire.
With Republicans controlling both houses of Congress in addition to the White House, investors are assuming that it will be easy for the Trump administration to fulfil promises to slash corporate taxes and scale back regulation. At the same time, more contentious proposals such as the introduction of tariffs were frequently dismissed by attendees as a “negotiating tactic”.
David Solomon, Goldman chief executive, said at the conference: “The market is basically saying they think the new administration will bring [regulation] back to a place where it’s more sensible.”
One hedge fund manager in attendance sums up the atmosphere more bluntly. “There are lots of giddy investors here getting excited about takeout targets,” he says. “M&A is now a real possibility because of the new administration. That’s been the most exciting [element of Trump’s proposals] . . . I think the mood is better than it’s been in the past four years.”
The emphasis on tax and deregulation is clear when looking at which sectors have been the biggest winners in the recent market rally: financial services and energy.
The S&P 500 financials sub-index has jumped almost 8 per cent since the vote, while the energy sub-index is up almost 7 per cent. Energy executives have celebrated the president-elect’s pledges to withdraw from the Paris climate agreement and open up federal lands for fracking in pursuit of US “energy dominance”.
The Russell 2000 index, which measures small cap companies, has also risen faster than the S&P thanks to its heavy weighting towards financial stocks, and a belief that smaller domestically focused companies have more to gain from corporate tax cuts.
Chris Shipley, co-chief investment officer at Fort Washington Investment Advisors, which manages about $86bn, says that “we believe the market has acted rationally since the election”, citing the concentration of gains in areas that could benefit from trends such as deregulation and M&A.
Even policies that most mainstream economists think would have a negative effect overall — like a sharp increase in tariffs — could ironically boost the relative appeal of US stocks by hitting other countries even harder.
The Europe-wide Stoxx 600 index, for example, has slipped since the election as investors bet the export-dependent region will be heavily hit by any increase in trade tensions. At the same time, the euro has dipped to a two-year low against the dollar.
“The ‘America First’ policy, not surprisingly, will be good for the US versus the rest of the world,” says Kay Herr, US chief investment officer for JPMorgan Asset Management’s global fixed income, currency and commodities team.
The worry among economists and many bond investors, however, is that Trump’s policies could create broader economic problems that would eventually be hard for the stock market to ignore.
Some of Trump’s policies, such as corporate tax cuts, could boost domestic growth. But with the economy already in a surprisingly robust state despite years of worries about a potential recession, some like former IMF chief economist Olivier Blanchard fear an “overheating” that would lead to a resurgence in inflation and a subsequent slowdown.
Demand-driven inflation could be exacerbated by supply-side pressures if Trump follows through with some of his more sweeping policy pledges.
On the campaign trail, Trump proposed a baseline 10 per cent import tariff on all goods made outside the US, and 60 per cent if they are made in China. Economists generally agree that the cost of tariffs falls substantially on the shoulders of consumers in the country enacting them. Walmart, the largest retailer in the US, warned this week it might have to raise prices if tariffs are introduced.
Deporting millions of undocumented immigrants, meanwhile, would remove a huge source of labour from the US workforce, driving up wages and reducing the capacity of US companies to supply goods and services.
Economists at Morgan Stanley and Deutsche Bank both predicted this week that Trump’s policies would drag on GDP growth by 2026, and make it harder for the Federal Reserve to bring inflation back to its 2 per cent target.
Tom Barkin, president of the Richmond Fed and a voting member on the rate-setting Federal Open Market Committee, says he understands concerns among the business community about tariffs reigniting inflation, and says the US was “somewhat more vulnerable to cost shocks” than in the past.
But some investors believe the risks to be minimal. “In our view, the inflationary concerns . . . regarding tariffs are overblown,” says Shipley of Fort Washington.
Fed policymakers have been quick to stress that they will not prejudge any potential policies before they have been officially announced, but bond investors have already scaled back their forecasts for how much the central bank will be able to cut interest rates over the next year.
Interest rate futures are now pricing in a fall in Fed rates to roughly 4 per cent by the end of 2025, from the current level of 4.5-4.75 per cent. In September, investors were betting they would fall below 3 per cent by then.
Meanwhile, the yield on the 10-year Treasury note, which rises when prices fall, is up about 0.8 percentage points since mid-September to 4.4 per cent. As a consequence, the average rate on a 30-year mortgage is also ticking upward, to near 7 per cent.
“The bond market has been very focused on deficits and fiscal expansion, and the equity market has been focused, it seems, on deregulation and the growth aspect,” says JPMorgan’s Herr. But “at some point, a higher [Treasury yield] is problematic to equities”.
In part, that is because higher bond yields represent an alternative source of attractive returns at much lower risk than stocks. But the more important impact could come from the warning signal a further increase in yields would represent.
The rise in yields is being driven by concerns both about inflation and also higher government debt levels, says Kristina Hooper, chief global market strategist at Invesco. “2024 marks the first year in which the US spends more to service its debt than it spends on its entire defence budget. And that’s not sustainable in my opinion over the longer term, and so we have to worry about the potential for a mini Liz Truss moment.”
Former UK prime minister Truss’s attempt to introduce billions of pounds of unfunded tax cuts and increased borrowing in 2022 caused a massive sell-off in British government debt that spilled into currency and equity markets.
The structure and scale of the US Treasury market makes this sort of “bond vigilantism” less likely, strategists and investors stress, but many institutions have begun paying more attention to the possibility.
“Over the next two to four years, do I think that there’s a very serious risk of bond vigilantes coming back? Absolutely. And that’s entirely based on what the multiyear plan will be, and the impact which comes out of it,” says Franklin Templeton’s Desai.
Trump and his advisers have dismissed concerns about their economic agenda, arguing that policies such as encouraging the domestic energy sector will help keep inflation low and growth high.
Even if they do not, several investors in Las Vegas this week suggested that the president-elect’s personal preoccupation with the stock market would help restrain him from the most potentially damaging policies.
“I think Trump and all his donors measure their success and happiness around where the US stock market is,” says the hedge fund manager. “It’s one reason why I’m pretty bullish despite the market being where it is.”
Economists have also consistently underestimated the resilience of the US economy in recent years. The combination of Trump’s attentiveness and economists’ poor past forecasting means even sceptical investors are wary of betting against the US market.
“There are risks out there,” says Colin Graham, head of multi-asset strategies at Robeco. “If some of the more extreme policies that were talked about during the campaign get implemented, our core view for next year is going to be wrong.
“But what is our biggest risk here? Missing out on the upside. The momentum is very strong.”
Data visualisation by Keith Fray and Chris Giles