Profound change swept across the electoral map on its way to the heart of Washington, D.C., last week. But what is the real size of the change in economic and investment conditions? In the last-minute anticipation and then immediate reaction to Donald Trump's win on Tuesday, almost everything broke in favor of risk markets. The quick and decisive election result immediately released pent-up tension over the prospect of a pending outcome. Then the distinct possibility of a Republican sweep in Congress led Trump to use old 2016 trading rules of seizing cyclical stocks, penny stocks, and financial stocks. The S&P 500's final jump of 4.7% during the week after it briefly jumped above the 6,000 threshold on Friday was set up almost perfectly by the market's three-week internalization of the fall rally, giving the average stock a chance to pull back even as the index remained… The S&P 500 is just below record levels. Almost as an afterthought, the Fed cut short-term interest rates by another quarter point and Chairman Jay Powell did nothing to dampen the chances of a further cut in six weeks. This comes in an economy that has been surprisingly on the upside and with inflation readings pausing their long decline just above the Fed's 2% target. Even what seemed like a reflection of tighter financial conditions lacked impact. The 10-year Treasury yield briefly rose above 4.4% on Wednesday, but even that was below spring highs and is at a level that has not shown to be holding the economy back much. The same goes for the dollar index, which has risen but remains below its mid-year highs. It's about as much bullish stimulus as investors would dare ask for — and more than most bears would choose to fight, at least for now. But, as always, there are nuances and potential complications to take into account. 2016 Trump Redux? For example, the market was already in a strong uptrend, with the S&P advancing 20% in 2024 by October. Cyclical stocks have been consistently outperforming defensive stocks, with financial stocks ahead of technology since August. Even the small-cap Russell 2000 made up more than half of its year-to-date deficit against the Nasdaq 100 between mid-July and mid-October, once the Fed turned more aggressively toward lowering interest rates. .SPX .RUT YTD Mountain S&P 500 vs. Russell 2000 Doug Ramsey, chief investment officer at the Leuthold Group since the beginning of the year, read some critical differences between November 2016 and the current moment: “Core inflation was just 2% when it won in 2016 and few people fear any inflationary impact from the tariffs.” Today, the core inflation rate was 3.3% and in 2016, the federal deficit was 3.0% of GDP “This was significant, but it was not seen as an impediment to steady government growth or significant corporate tax cuts.” The deficit now exceeds 6% of GDP. “Although investor sentiment ahead of the 2016 vote was restrained, one component of our confidence composite (consumer expectations of stock price gains in the next 12 months) rose to an all-time high just one month ago,” he adds. The S&P 500 before the 2016 election was at the same level as 18 months earlier and traded at 17 times earnings, with margins declining after the 2015-16 earnings slump. Now, the S&P is up 44% over the past 18 months, and its P/E ratio is above 22 on higher margins. The US economy had been experiencing below-average growth and had fallen short of the 2% inflation target for more than half a decade by the 2016 election. Today we have emerged from an inflation shock with real GDP above trend over the past three years. . Investment-grade corporate credit spreads at the time were twice what they are now, leaving less room for financial conditions to improve going forward. In other words, when Trump's reflation policy mix of tax cuts and deregulation emerged in the wake of his surprise victory in 2016, a revival of inflation was precisely what the economy needed. Now, expansionary policy (excluding potentially tough tariffs and currently stalled deportation programs) presents itself as a potential accelerant of the trends already underway. Even then, value stocks and small caps only outperformed for about two months before growth stocks and defensive sectors dominated the S&P 500 during a remarkably quiet and strong year in 2017. Here's the relationship between value versus growth in the S&P 500 since 2014 As for small caps, institutional players have been maneuvering to play a rebound over the past couple of months, leaving positions in Russell 2000 futures very high. Scott Krohnert, equity strategist at Citi, regularly calculates the five-year earnings growth rate in stocks at a given valuation, and said Friday that with the election week rally, “our implied estimate for growth has moved to 13.6% (annualized) from 12.4%.” Kronert estimates that the move “fully prices the tax cut on domestic producers to 15%, which by our calculations represents an annualized free cash flow impact of +0.6%.” This leaves the remaining +0.6% for deregulation and tax cuts for households. This does not create much room to cut taxes on domestic producers by 0.6% on an annual basis. Growing negatives from tariffs and/or higher interest rates tied into deficit concerns, especially against a backdrop of euphoric sentiment. His call for investors to avoid any near-term rally that would lift the S&P above the “bullish case” target of 6,100 for the end of the year. Tesla Week 30% All fair and sober reviews. However, even if the math suggests an unexciting fundamental return setup, bull markets also feed on the stories, emotions and money flows they encourage. If today's contractionary policy prescription is not necessary to heal a damaged economy, markets may be using it for entertainment purposes. To be sure, this may have been previewed by the way crowd-favorite Tesla shares rose nearly 30% over the week, the way shares were heavily shorted, and the vertical rise in stocks like Goldman Sachs on the back of merger expectations and the IPO frenzy. Initial year. It is unleashed. TSLA 5D Mountain Tesla, 5 days More specifically, just the hope of a potential corporate tax cut and the industry being able to change regulations in its favor could sustain the feeling that earnings growth could improve by late next year and perhaps prolong an economic cycle that has been around for quite some time. He seemed to be losing momentum. The S&P 500 is certainly up by some metrics, pushing above the high end of a two-year bull market run. At the same time, this means that a pullback should be unsurprising but that a final top is unlikely to be within reach. Market breadth has also been largely disappointing all week due to this strong rise in the index, a sign of how firmly the market is in sorting out policy winners from the rest of the pack. Investors have been reducing their exposure and hedging aggressively in the election, so there is likely still room for the Street to “re-risk” portfolios further. However, after the glut of market-friendly news, it's time to monitor investor sentiment and positions to grow towards the unstable bullish frontier – even if such readings are not always a major impediment to an upward seasonal bias towards the end of the year.
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The bull market is back on Trump's fervor as traders race to grab small caps, banks and Tesla
