I'm not sure what the bigger surprise is: the strength of Trump's election victory, or the fact that the election is (apparently) over without a crisis!
For well over a year, there has been a huge amount of fear surrounding this election. Beyond the normal anxiety over which candidate would win, there was abnormal fear regarding whether the result would drag out, if the loser would accept defeat, and potentially even whether it could lead to violence.
All of this event-driven anxiety, telegraphed so far ahead into the future, means there was an enormous amount of hedging against market downside in place coming into the election. With those worst-case outcomes apparently avoided, a huge amount of that downside hedging expired or was otherwise removed today. The technical details get a bit wonky to explain, but when hedges get unwound without a big downside event transpiring, that results in buying of stock, which pushes the market higher.
That's the bulk of what markets experienced today. That's not to say investors aren't excited about the prospect of another Trump presidency, who was quite good for stocks during his first term. (One market pundit affectionately referred to him as "President Pump" during his first term due to his frequent references to the stock market, which has been unusual for most presidents.) There was definitely a Trump "flavor" to what rallied and what didn't today.
But a lot of it was relatively mechanical, which can be observed in the relative order to the gains. Generally speaking, the most speculative stuff tended to rally the most: Bitcoin was up +9.5%, small-company stocks +5.8%, the S&P 500 Index +2.5%, our large quality-focused holding (FCTE) +0.7%. This is normally going to be the case, as certain assets are just more inherently volatile to begin with and tend to move more dramatically than lower-volatility assets.
There's also a logic to today's moves from a hedging standpoint: if you were inclined to try to hedge against downside risk before the election, would you choose hedges that would pay off a lot or a little in the case of a market plunge? Probably a lot, so hedging the Russell 2000 index (small companies) might make more sense than the S&P 500 Index (large companies). The S&P 500 Index would make more sense to hedge than quality large-cap stocks, and so forth. As hedges were removed, those things bounced more, like a ball held further underwater.
Looking ahead
It's reasonable to wonder whether this was just a short-lived relief rally. I don't think it necessarily will be. I've been discussing the case for a year-end rally for a while now, based primarily on structural factors. The reduction of market volatility (as we've been discussing) has clear implications that typically result in stocks rising. Other year-end structural factors are sitting directly ahead, especially given this year's strong market gains, which have the potential to force investors to chase the market higher.
The biggest risk to this bullish setup is rising interest rates. Part of the "Trump Trade" playbook has been an expectation of higher interest rates, based on his plans/reputation as a big spender and tax cutter. As the odds of a Trump victory appeared to rise in recent weeks, so too have longer-term interest rates. Last night, as Trump's victory became more certain, the 10-year Treasury yield rose from 4.30% to 4.45%. Less than a month ago, that rate was 4.0% and a month before that it was 3.62%.
Investors have seen multiple instances over the past 2-3 years when interest rates rose rapidly enough to cause the stock market indigestion. That could certainly happen again should rates continue rapidly higher. Some of the positive year-end structural dynamics for the stock market could also be squelched if bond values decline (as a result of higher rates) sufficiently that it requires balanced portfolios to sell stocks as year-end approaches in order to buy more bonds (to rebalance toward their 60/40 or similar target allocations).
SMI is well-positioned
We'll unpack the market implications of a Trump presidency in more detail later this month in our December newsletter. And we'll likely dive even deeper into some of the most important themes at year-end when we publish our 2025 preview.
The great news is that SMI members are already well-positioned and don't need to do anything other than enjoy the upside. Hopefully, you resisted any temptation to sell positions in the lead-up to the election and are poised to reap the benefits of a market rally, ideally one that lasts through year-end. Of course, not everything in our portfolios is going to respond exactly the same way. Gold, a huge winner for us all year long, was down today. As I mentioned, high-quality stocks (FCTE) had a muted bounce relative to other things.
On the other hand, Sector Rotation investors enjoyed a crazy +13.4% gain today, while several of our other stock positions also enjoyed solid gains. Meanwhile, our primary Bond Upgrading holding didn't lose any ground today while the Bloomberg U.S. Aggregate Bond Index fell -0.8%. We discussed why this conservative bond positioning made sense to us in our latest Upgrading discussion last week — today was a good illustration of why we wanted to limit our bond exposure.
There's plenty to unpack in the weeks and months ahead. For now, there is powerful structural support behind this market rally and it's reasonable to expect stocks to continue rising. But keep an eye on longer-term bond yields, as they're the biggest potential spoiler to an otherwise bullish setup.
