Column: Balfour On U.S. Election & More
[Opinion column written by James Balfour]
It was tight, most polls were unable to split the candidates, the uncertainty in the swing states meant both candidates had routes to 1600 Pennsylvania Avenue. However it is now clear, that despite many commentators stating President Trump had a ceiling to his vote share, he had picked up votes and that Vice-President Harris had not stepped up the share from President Biden’s base in 2020. A win in the popular vote seems a certainty now, alongside the Republican party taking control in the Senate after picking up three seats. The remaining question is about the House of Representatives, President Trump needs their approval for changes to tax and immigration, if this turns red then for the next two years the Democrats will have limited political weight.
A combination of clarity and the President Trump proposals pushed the markets higher. The S&P 500 Index opened just under 2% up, at an all time high, the Russell 2000 Index up 4%. In the bond market, 10-year yields increased 20 basis points to nearly 4.5%, though it is still fully expected for the Fed to make a 25-basis point cut to rates on 7th November.
Banks are seen to be major beneficiaries in the policy agenda with looser regulation expected, potentially driving more M&A activity. JPMorgan opened 9% stronger, Goldman Sachs over 10%, with the KBW Bank Index rallying over 8% as the whole sector was dragged higher, Bank of Butterfield was up 6% in initial trading.
Technology which has been the dominate sector through 2024 suffered a more mixed reaction. Of the Magnificent Seven, Tesla led the way, surging 12% higher reflecting the close relationship Elon Musk has had with the incoming President. Alphabet reacted slightly better than the overall market on the expectation that the Department of Justice investigation on them splitting up could be dropped, however Apple lagged as it has a dependance on Asian importations for products that may suffer tariffs.
The Green Energy sector took the most significant hammering in early trading, expecting less favorable policies from the President elect that they currently see under the Democratic administration. Enphase Energy and First Solar both saw over 14% negative moves, even the larger Nextera Energy lost nearly $10 billion market capital. No policies have changed but the Energy Select Sector up over 3% gives a strong indication of what the market believes will be the divergence in upcoming policy.
It will take some time for the dust to settle on these initial reactions but there are now important considerations for what the markets will do moving into 2025. It is rare to see mid-caps rallying strongly at the same time that 10-year interest rates also increase. Smaller companies traditionally have more debt and also sensitivity to rate moves, it is clear from the rhetoric that President Trump is domestically focused but this could be a mixed blessing for some domestic names. Investment at higher rates could stress smaller balance sheets and in a cyclical segment of the market it may leverage the sector more to boom or bust operations. This may drive a more segmented market of winners and losers, so opportunities in the sector that has been undervalued but they could come with greater risk as interest costs erode their cash generation.
Economic policy is the critical segment that has the ability to shape the performance of the markets in 2025. President Trump will look to set in stone the continuation of his tax policies, cementing the tax cuts for citizens. The economic benefit of this will be more muted than before, this is just retaining the tax position rather than putting more cash into the economy. The more critical market factor will be the imposition of tariffs and the response that these generate. Consumers are known to pay the ultimate price, but there can be benefits from increased domestic production. Washing machines had tariffs imposed in 2018, not only did prices of imported machines increase but the domestic producers moved prices as well. Despite no tariffs imposed on tumble dryers their prices inflated to match; consumers normally buy these items in pairs. Jobs in the U.S. were created as production was shifted domestically, however the economic impact of these didn’t outweigh the inflated costs to consumers. If President Trump does enact tariffs, then the US domestic economy will benefit in the medium term, but the initial impact will likely be inflation and the scale of that will depend on what corporates pass through.
Chairman Powell now has a conundrum, short term market data still indicates the need to cut interest rates, but the previous expectation of over ten cuts through to 2026 has evaporated. With President Trump’s intended policies adding to the national debt, stimulating domestic investment and likely creating inflation the Fed will be minded to pair back the need for multiple rate cuts. The fallout has already been the 10-year interest rate increasing 50 basis points in the last month, and if debt continues to increase unchecked then investors will require greater return for the inherent increased risk. The impact is that mortgage rates will remain higher and this does directly impact consumers, something that if inflation also bites could soften the benefit of President Trump’s policies on economic growth. For investors there are now higher interest rates for longer expected in fixed income markets, but with the tax cuts promised there could be a tightening of spreads as large corporates have more attractive debt profiles than the U.S government.
All these potential policy changes will create opportunities as markets tend to overreact to the rumor and then slowly establish the true economic impact. If there is looser regulation in financial sectors then not only will this benefit those names, but generate M&A in segments that might not have been expected. Underlying assumptions on earnings changes will be slower to transform but as the wood becomes clear from the trees the medium-term impact will highlight potential undervalued names. There are over two months before President Trump is inaugurated back into the White House but the implications of his second term have already flushed responses out the market that could set the stage for the next four years.
- James Balfour, CFA, Senior Portfolio Manager at LOM
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