Post US Election Update: Driving Faster vs Going Farther
What happened last week?
The S&P 500, Dow and Nasdaq added 4.66%, 4.61% and 5.74% after a post-election rally that also sent the Russell 2000 index of small-cap stocks 8.57% higher.
President-elect Donald Trump looks to return to office with a GOP-controlled Congress that for the next two years should provide him with a tailwind in enacting his priorities on taxes, spending, immigration, trade, and deregulation.
Two days later the Fed lowered rates by 0.25%, said the election will have no immediate effect on monetary policy and Chair Powell made clear he intends to complete his term.
What does this mean for investors?
US inflation measures are poised to slow further in early 2025. Most importantly, any net US tax reductions are unlikely before calendar 2026. However, folding tariffs and tax cuts into the outlook, we are revising our interest rate assumptions for next year. We expect the Fed funds rate to bottom in a range of 3.5%–4.0% and 10-year US Treasuries to rise toward 4.75% by the end of 2025. We believe the longer-term averages for both measures will be lower, near 3% and 4%, respectively.
3 Things to Know
Can Income Overcome Inflation in Trump 2.0?
As expected, in reducing interest rates further on Thursday, Fed Chair Powell refused to speculate on how White House and Congressional policies would impact monetary policy.
He noted the great uncertainty around coming policy choices, the long road ahead to implementation, and the Fed’s posture to focus on today’s known challenges.
This includes a slowing US labor market at a time when the Fed funds rate is still 4.50%-4.75%. This is still far above the Fed’s estimate of the long-run average policy rate of 2.9%.
Inflation measures are still poised to drop in early 2025, in our view. This will be driven by the strengthening US dollar, falling import prices and known lags between market prices and the CPI’s measures of shelter inflation.
The shelter measure of inflation is likely to continue declining, even if housing affordability weakens. This means that the Fed will likely hits its target of 2% inflation even on the core rate during the first half of next year.
The highly concentrated tariffs on Chinese imports in 2018 doubled US import duty revenue yet had remarkably little impact on the net inflation rate. Much larger tariffs and tax cuts would push back against the current disinflationary trend, but not before some further inflation progress is measured.
Trump Likely to Push for Faster, US-Centric Growth
The coming administration is likely to use expected tariff revenue increases and “dynamic scoring” of growth measures to drive some small net tax cuts in 2026. This is a far cry from the large tax increases that would take place at the start of 2026 under current law.
It is also far from “eliminating the income tax,” an idea mentioned by Trump on the campaign trail. In essence, Congressional restraints on fiscal action means the US is very unlikely to see a radically different fiscal course. But even a mildly stimulative fiscal outlook, restraints on foreign supply, and an easing Fed should result in somewhat higher long-term yields.
With yields moving higher on stronger growth and inflation data recently — and the bond market pricing in higher odds of a “red sweep” in recent months — US yields did not rise markedly in the past week.
The “short base” in the bond market has been deep for a long time, already bracing for higher yields. This makes further yield increases less likely in the short term.
Taking the many uncertain factors into account, we believe US 10-year yields will rise toward 4.75% by the end of 2025. This is high compared to global yields and somewhat higher than long-term drivers of growth — such as demographic trends — would suggest.
Personnel Likely to Determine Policy in new US Cabinet
Our uncertainty over election results has nearly ended but is replaced with great uncertainty over the coming administration’s policy emphasis and process of implementation.
Our Global Investment Committee (GIC) overweight in US equities and slight underweight in non-equities — including overweights to small and mid-cap US growth shares — was well positioned for the market reaction to the election.
Non-US shares trade at a mere 13.3X 2025 EPS estimates and look like a compelling value. But they did not drop significantly in US dollar terms as a prospective new investor might hope.
We will still consider the shifts in relative value occurring in global markets, including the sharp rally in the S&P 500. US small and mid-cap growth equities, on the other hand, are still trading about 5% lower in value than their long-term average and an historically large 33% below large cap growth shares.
After several years of increasing market concentration in a few large cap tech firms — some with trade and regulatory risk — we believe suitable investors should consider broadening portfolio holdings to include “left behind” high quality growth equities.
See our weekly CIO Strategy Bulletin for more details