Weekly Investment Update (11/08/2024)

The market continues to digest the outcome of the U.S. presidential election as well as the pending results determining the balance of power in Congress. Market movements remain consistent with preelection trends, with both stocks and interest rates moving higher. That said, history is marked by numerous failed market narratives around elections, so we urge caution in extrapolating from dramatic near-term price changes.

It is noteworthy that small caps, industrials, and financials moved significantly higher even as interest rates reached multi-month highs. Meanwhile, oil prices also have risen, despite investor expectations of higher production. This combination suggests that the market is repricing the growth outlook upward, with optimism around growth potential outweighing concerns over trade policy and inflation. We agree that the likely policy backdrop could push growth higher than we’ve been expecting. Although inflation can continue to moderate in that scenario, one must acknowledge sticky inflation is a greater possibility under a higher growth backdrop. Overall, though, we expect the benefits of higher growth to outweigh inflation pressures, creating a positive environment for markets.

The Federal Reserve cut interest rates by another 25 basis points this week, and we expect it will do so again in December. It will take time for the Trump administration’s policies to crystallize and impact economic data, and we therefore believe the Fed is likely to be more sensitive to economic indicators than to speculation around potential changes in trade, fiscal, and immigration policies.

Risk Assets Rally After Former President Trump Defeats Vice President Harris

What is happening: Former President Trump defeated Vice President Harris in the 2024 U.S. presidential election. Republicans also gained control of the Senate, while the House of Representatives remains too close to call as of the time of this writing. Even though the outlook for the House is still to be determined, prediction markets are indicating a very narrow Republican majority, which means Republicans would control the presidency, Senate, and House in 2025.

Former President Trump exceeded expectations for a close election, now appearing set to win every swing state and gain over 300 electoral college votes. Stocks rallied on the back of the election results, likely in anticipation of deregulation efforts and the prospect of tax cut extensions, with strength seen especially in small caps and financials. U.S. equities broadly outperformed global peers as the S&P 500 saw its best post-election day performance ever, rising 2.5%. Meanwhile, bond yields faced upward pressure, potentially on tariff and deficit concerns, but also in reaction to an increase in growth expectations.

Why it matters: While policy is rarely the most important factor driving markets, policy changes can affect the outlook for the economy and markets. A key focus for markets is tariff policy given the potential to affect the inflation outlook. We view an increase in tariffs on China as more probable than a universal tariff, which would likely face legal challenges. Trump’s plans to restrict immigration would likely limit additional labor supply, though we note that supply and demand have recently come into much better balance. The president elect is also expected to take a lighter-touch approach to regulation, particularly regarding the energy and financial sectors, an approach that should provide a more favorable backdrop for M&A.

While many of Trump’s policy priorities can be largely implemented through executive action, the makeup of Congress is influential for fiscal policy. President-elect Trump has vowed to extend his 2017 tax cuts, which are set to expire at the end of 2025. Should the Republicans win the House, we expect most, if not all, of the 2017 tax legislation to be extended. However, if the Democrats take the House, Republicans may need to compromise on some of the expiring provisions. The outlook for fiscal policy has implications for the trajectory of the U.S. deficit, which we discuss further in our A Closer Look, “U.S. Government Debt and Deficits: Do They Matter?” Even a thin GOP majority is likely, to a degree, to serve as a limiting factor on fiscal policy given concerns about the deficit. For more information on the election implications on markets, tax, and estate planning, please contact your advisor about our recent webinar.

Federal Reserve Cuts Interest Rates by a Further 25 Basis Points

What is happening: The Federal Reserve cut interest rates by 25 basis points this week, bringing the target rate to 4.50%-4.75%. The decision was unanimous, with all committee members supporting the reduction, including Michelle Bowman, the sole dissenter against the 50-basis-point cut in the September meeting. Chair Jerome Powell indicated that the risks to both unemployment and inflation are now approximately balanced; however, the committee intends to place greater emphasis on the full-employment aspect of its dual mandate, with less focus on the price-stability objective given ongoing disinflationary trends.

Powell highlighted that monetary policy remains restrictive, and the committee expects inflation to continue on a downward path, with economic data continuing to support a measured pace of rate cuts toward a neutral level. While the unemployment rate remains historically low, Powell acknowledged a slight increase from last year, signaling that the Fed’s recalibrated focus will be on the labor market in upcoming meetings.

Why it matters: While inflation is nearing the Fed’s target of 2%, uncertainty surrounds President-elect Trump's proposed economic policies. In particular, the spotlight has been on broad tariffs which are perceived as potentially inflationary. Recently, long-term borrowing costs have also risen, creating a complex landscape for the Fed, where it must strike a delicate balance between supporting economic growth and controlling inflation amid rising unemployment and uncertain future fiscal policy.

The next Federal Reserve meeting is on December 19, where an additional 25 basis point cut is currently expected, and we will see the release of an updated Summary of Economic Projections. This document will provide the first insights into how committee members expect a Trump presidency to influence their forecasts of future rate cuts and the long-term equilibrium interest rate — though their estimates will place much more emphasis on updated economic conditions rather than policy speculation.

We believe the Fed will continue to have a dovish reaction function with the aim of preventing a downturn in the labor market. Interest rates are still restrictive, and a sizable number of cuts will be required to return interest rates to the Fed’s estimate of neutral. It will be important to see how promises on the campaign trail translate to actual policies, though easier monetary policy and expansionary fiscal policy will likely be a supportive environment for risk assets, in our view. As a result, our asset allocation maintains an overweight to equities in portfolios.