Market Update: Post Election Rollercoaster
Post-election, investors have experienced a rollercoaster not only in stocks but also in bonds, commodities, and currencies. The most important factor at play is global investors' aversion to US assets. This is not just a story of avoiding policy uncertainty amid rising deficits but also one of sector composition within the underlying markets.
The US came off back-to-back years of outperformance, making some mean reversion warranted. Stock market indexes were overvalued, while international assets had more reasonable valuations. Policy uncertainty and chaotic rhetoric from Washington have driven down the multiples investors are willing to pay for US assets. Rising US deficits create a headwind for future growth, and the role of the US dollar as the world's reserve currency was put at risk as the currency no longer appeared as safe as it once was. Given this backdrop, global investors are no longer willing to lend money to the US at below-market rates and demand higher interest rates to fund those deficits. Higher interest rates further pull down the multiples that stock investors will pay since they are buying a stream of future cash flows that, when discounted at a higher rate, reduce the asset's fundamental value. Now, the US stock market no longer looks attractive, bond yields are rising—threatening existing bond prices—and the US currency is depreciating. Meanwhile, policy uncertainty continues to cloud Washington, creating a perfect storm for investor aversion to US assets.
Compounding international outperformance is the sector composition of foreign indexes, which have smaller weightings toward technology-driven businesses and focus more on the traditional economy. Technology businesses have suffered from overvaluation and rising interest rates, so lower technology sector weights in global indexes have boosted performance. For example, in the Eurozone, technology stocks make up about 14% of the index, compared to roughly 34% for the S&P 500. Communication services in the US have about a 10% weighting, whereas that number is around 5.4% in the Eurozone. However, US communication services resemble technology more closely than those in the Eurozone. In other words, the overseas rally has also been a value versus growth story, with those stocks resembling more of a value play than US stocks. Even within the US, value stocks still carry about a 10.5% weighting in technology.
Breaking down post-election performance reveals three distinct periods: The first was a phase of euphoria lasting until Inauguration Day, where the S&P 500 returned 5.4%, driven by optimism around Trumponomics, with cyclical stocks and smaller companies gaining the most. From Inauguration through April, the S&P 500 declined 7.86% in a clear risk-off trade that ensued after what's known as Liberation Day, where defensive stocks outperformed and short-term high-quality bonds were favored as investors feared long-term U.S. debt, given its size and rising deficits. During this period of uncertainty, which prompted a flight to quality (where investors rush into safe assets), but investors actually sold the dollar rather than demanding more of it. This is unprecedented and speaks to the shift in investor sentiment regarding U.S. deficits and policy choices. Finally, from May until now, the market has risen 11.9%, marked by a return of tech and AI dominance, with those sectors performing best.
Looking ahead, the market’s direction will depend on macroeconomic clarity and economic growth. If the administration provides clear trade and policy guidelines, the Trumponomics trade could return. If concerns about a longer period of higher interest rates lead to recession fears, a risk-off trade could follow. If uncertainty persists with trade and slowing growth, the Fed may have room to lower rates, easing pressure and boosting the intrinsic value of future cash flows from technology-related companies. The focus will remain on the intrinsic growth potential of AI-related tech, which may continue to outperform.
