TRUMP 2.0
US exceptionalism has been the theme for 2024 with the US stock market dominating on the global front. Exhibit 1, below highlights this outperformance with both the S&P 500 Index and the Nasdaq Composite Index returning 26.52% and 31.15% respectively on a price appreciation basis relative to other global markets.
This outperformance has been underpinned by US corporate earnings growth (the market at present is forecasting 10.46% forward earnings growth for 2025), a resilient US economy (The Atlanta Fed GDPNow forecast now stands at 3.33% growth for Q4, 2024 as at 12/09/24) and a reasonably strong labour market. With the Fed still committed to a path of lowering interest rates, continued equity gains are further supported. However, while inflation has moderated, it is still a concern, as results remain above the 2% target. Headline CPI for November rose to 2.7% (versus 2.6% previously) and core CPI (less food and energy) inflation registered 3.3% for the third straight month.
It is interesting to note that while the Fed has reduced the Fed Funds Target Rate (upper bound) by 75 bps from the first cut of 50 bps on 09/18/24, bond yields are actually higher across the term structure from around the 1 yr mark onwards (See Exhibit 2).
This can be interpreted as the bond market discounting higher inflation and the market now is pricing in 3.7 rate cuts by year end 2025 (as at 12/11/24) (See Exhibit 3), which is significantly down from 10.17 just 3 months prior.
Therefore, the Fed still has their work cut out for them as the potential for Fed policy error is still very much a concern. Do they let inflation trend above the 2% target risking a reacceleration or become more restrictive? This backdrop becomes even more complicated when factoring in President Trump’s proposed economic policies.
Trump Proofing
Some clients have recently been expressing concern in terms of how a 2nd term Trump presidency could impact their investment portfolios and to what extent they should be worried. A look at President’s Trump’s first term (January 2017 to January 2021), highlights the SPX Index performing quite well, up 67.77% on a price appreciation basis. Many of the policies implemented i.e. tax reductions, deregulation, immigration, trade policy and tariffs are once again on the cards for 2025 implementation. It should be noted that Inflation only hit a peak of 2.9% on 07/31/18 up from 1.6% on 06/30/17. This was on the back of a growing economy with GDP moving from 2.3% to 3.3% over the same time period on a YoY basis and would not be categorized as alarming.
Sector Performance
Exhibit 4, below, highlights the various sector performance over this period of higher inflation, while Exhibit 5 highlights the same sector performance for the entire term inclusive of the COVID recession Feb to March of 2020.
Sectors that performed notably well during Trump 1.0
Tech Stocks: Technology was the best performing sector inclusive of both pre and post inflation peak aspects of the term, recording substantial growth supported by the tax cuts and the continuing trend of digitalization.
Consumer discretionary: A strengthening economy coupled with a pro-business environment boded quite well for consumer discretionary stocks with the sector generating the 2nd best returns (inclusive of both pre and post inflation peak).
Financials: Financial institutions fared well under deregulation and more favorable corporate taxes.
Materials: Tariffs and trade protectionism measures had various effects on industry categories within materials and sparked some retaliatory measures from US trading partners. While companies in specialty chemicals, packaging and containers for example were top performers, steel producers and farming/ agriculture stocks did not fare as well.
Healthcare: Despite periods of volatility involving uncertainty around healthcare reform, this sector was an outperformer. This was especially the case with bio tech and vaccine stocks towards the end of the first term which saw tremendous growth in response to Covid.
Sectors that performed notably poor
Energy: Policy geared towards domestic production and relaxed environmental regulations supported energy stocks especially in the first couple of years. However, this drastically changed during Covid with travel bans and lockdowns which resulted in the sector being the worst performer.
How should investors be positioned this time around?
As previously noted, the US economy has demonstrated strong resilience. Corporate earnings are projected to grow on a forward basis for 2025, and GDP growth for Q4 of 2024 and real wage growth is tracking above inflation, while the labor market is still relatively stable. This suggests that the Fed may rule out some rate cuts for 2025, as reflected in Fed Futures, while maintaining a cautious stance. Despite this, the environment remains generally supportive for US equities, though some volatility could arise if inflationary pressures continue to persist, especially given the current high valuation levels (SPX trading at a forward P/E multiple of 25.68X as at 12/13/24).
Given Trump’s policies on the surface are deemed inflationary, there are parallels to what transpired within his 1st term which can provide clues to investors this time around.
As previously mentioned, technology stocks were winners under the previous Trump administration. Even with the Mag 7 stocks up 72.99% on an YTD basis, Exhibit 6 highlights that valuations have mostly been trending sideways in a horizontal channel from March 2023. Factoring the recent breakout to the upside, at current levels they are still 19.2% off from the next peak established on 11/19/22 and 38.2% from the one established on 12/26/19. Therefore, from a valuation standpoint they are still relatively attractive.
Financials, energy, consumer discretionary, and US focused industrials stand also to benefit with deregulation and tax cuts. As part of an inflation hedge, gold and real assets e.g. real estate are attractive. While Small caps have been in the spotlight (given their recent strong performance), it should be noted that they are still trading at some of the cheapest levels relative to their large cap counterparts going back to 02/06/01 when the Fed was in a rate cutting cycle (See Exhibit 7).
However, investors should focus on those companies within the space that have sound balance sheets with little to no leverage should interest rates continue to rise. Fixed Income remains attractive for income generation.
Conclusion
While concerns about the impact of the second Trump presidency on investment portfolios are valid, historical trends from his first term offer valuable insights for investors. With the US economy showing resilience, corporate earnings projections still favourable, and positive growth expectations for 2025, there are opportunities across various sectors, particularly in technology, financials, Industrials (domestically focused), energy, and consumer discretionary, which could benefit from continued deregulation and tax policies. However, the risk of volatility remains, especially with inflationary pressures building and the market trading at robust valuations. Real assets such as gold and real estate may benefit investors should inflationary pressures persist while fixed income as an asset class remains viable as portfolios navigate potential challenges ahead.
