Weekly Investment Update (11/15/2024)

Markets took on a somewhat neutral tone this week as investors balanced optimism around the potential for a pro-growth policy backdrop with the recent move higher in interest rates. For now, stocks have largely ignored the risks surrounding rising bond yields, assuming that faster growth means the economy can handle higher rates. At the same time, the bond market continues to price in fewer rate cuts between now and the end of 2025 versus what was expected only a few weeks ago. That said, we still expect the Fed to cut another 25 basis points in December in an effort to address certain signs of emerging labor market weakness by creating a more neutral policy backdrop. With the Consumer Price Index (CPI) for October rising 2.6%, aligning with economists' expectations, the Fed is likely to view the inflation backdrop as still supportive of further monetary policy easing. That said, Fed Chair Powell noted this week that the economy is not sending signals indicating the need for rapid policy easing.

We are attuned to the risk that bond yields remain elevated as proposed policies from the incoming Trump administration impact growth and inflation expectations. Higher rates driven solely by a material increase in inflation expectations could serve as an impediment to equity market gains and likely become a headwind to the recent rally in mid and small cap equities. We believe that, although inflation remains above the Fed’s target, lagging measures of shelter costs are a meaningful contributor to the current calculation.

Disinflation Continues, but Cumulative Impacts of Inflation Dampen Consumer Sentiment and Market Dynamics

What is happening: The October CPI report was in line with expectations as headline figures rose from 2.4% year-over-year to 2.6%, while the core rate remained at 3.3% year-over-year. The headline increase was partially due to base effects, where lower inflation rates a year prior can cause a greater increase in the current period. Core services inflation continues to slow the disinflation process, increasing by 0.3% month-on-month, while core goods prices were unchanged. On a monthly basis, core goods were flat after increasing in September as falling apparel prices were offset by a rise in used car prices.

Core services inflation continues to stall due to sticky shelter prices, the largest category within services, increasing at 0.4% month-on-month. Owners’ equivalent rent, a subset of shelter and the largest single component of CPI, increased by the same amount. Overall, shelter was responsible for over half of the monthly increase in headline CPI. Looking ahead, real time rental costs indicate easing price pressures, a trend that we expect to be reflected in CPI over the coming months.

Why it matters: While headline inflation rates suggest continued moderation ahead, the lingering effects of cumulative price increases have influenced voter behavior and continue to pose challenges for small businesses. Of the individuals who responded in exit polls that “inflation was a severe hardship,” 73% voted for Trump. Although headline inflation has cooled to 2.6%, individuals are feeling the impact of the cumulative increase in prices, which are up 25% since the start of 2019. Notably, small businesses continue to cite inflation as their single largest problem.

Financial markets are recalibrating to anticipated policy changes amid an economic backdrop that was already complex given the uniqueness of the post-COVID business cycle. The recent rise in yields can be attributed partly to expectations surrounding policy changes on taxes, tariffs, and immigration, with the post-election rise in inflation breakevens signifying some increase in inflation fears. Although economic data remains somewhat mixed (October retail sales coming in below expectations but upward revisions to September), optimism for stronger economic growth has also been a driver of the move higher in yields. U.S. Inflation breakevens have risen to the highest level seen this year and further increased on Election Day; however, since the election, breakevens have started to recede while yields have stayed elevated, signaling that some of the rise in yields can be attributed to stronger growth rather than just inflation. Should we get a combination of stronger economic growth, somewhat stickier inflation, and fewer rate cuts, we continue to believe that stocks could continue to rise. The biggest impact may be market leadership, and we continue to evaluate areas of the market most likely to benefit.

Trump’s Appointments Indicate Focus on Immigration and National Security

What is happening: President-elect Trump has moved quickly to start filling key roles in his new administration. Trump’s hardline approach to immigration is evident in the elevation of Stephen Miller to deputy chief of staff and the appointment of Tom Homan to border czar. Miller, an architect of mass deportation plans, has said the administration could aim to deport approximately one million people per year — a large number but still much smaller than some of the numbers floated during Trump’s campaign.

Trump has additionally selected Marco Rubio for secretary of state and Mike Waltz for national security advisor. Marco Rubio, a senator from Florida who has a history of being staunchly opposed to Iran, Cuba, China, and North Korea, is supporting the elimination of the nuclear deal and increased sanctions on Iran. Mike Waltz, the representative from Florida and a Green Beret veteran, previously served as a counterterrorism adviser to Vice President Dick Cheney and is known for being particularly hawkish on China and Iran.

President Trump has also appointed Elon Musk and Vivek Ramaswamy, an entrepreneur and former Republican presidential candidate, respectively, to lead the Department of Government Efficiency (DOGE). Because DOGE will be an advisory body to the Trump administration (not a new federal agency), it cannot make or enforce regulations.

Why it matters: It has often been said that “personnel is policy,” and this notion seems to ring especially true for a Trump administration. Immigration and border enforcement have emerged as key issues in Trump’s picks. While we expect Trump to initiate a “remain in Mexico” policy to shut down the border immediately upon assuming office, mass deportation efforts are expected to be costly as well as legally and operationally challenging.

Though it remains unclear if he has been picked (or would accept or be confirmed to the role), the appointment of Bob Lighthizer as U.S. trade representative would indicate Trump’s serious intention to enact tariffs. Meanwhile, Scott Bessent, a hedge fund manager who is considered a likely candidate for Treasury secretary, could provide a counterbalance. The combination of Lighthizer as U.S. trade representative and Bessent as U.S. Treasury secretary could create tension over trade policy given Lighthizer's intent to ramp up tariffs and Bessent’s indication that Trump is a free trader who would “escalate to de-escalate.”

Taking a step back amid the flurry of announcements, it is important to remember that while President-elect Trump has the authority to appoint White House positions, most cabinet-level positions require Senate confirmation. Candidates such as Matt Gaetz (for attorney general) and RFK Jr. (for secretary of health and human services) would likely face difficult confirmations in the Senate, even with a Republican majority. We note that Republican senators recently opted for an “establishment” rather than a far-right choice in picking a new leader. Additionally, the ability of DOGE to enact spending cuts will largely depend not only on the Trump administration but also on Congress, which maintains the “power of the purse.”

Lastly, we highlight that Trump’s selection of three members of the House of Representatives could make passing tax legislation early in 2025 more challenging given the narrow Republican majority in the House. While we continually evaluate the potential impact that policy changes can have on markets and portfolios, we think it is also important to keep in mind that there has historically been a gap between the initial proposals of a candidate and their appointees and what is eventually implemented after negotiations have taken place.