iCapital Market Pulse: Beyond the Election

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It has been a busy stretch from a macro policy perspective, not only because of the U.S. presidential election, but also as a result of last week’s Fed meeting. Markets reacted favorably and posted their best weekly gain in over a year, as the S&P 500 surpassed 6,000 recording its 51st new record high of the year while at the same time the volatility index collapsed.¹ This “sigh of relief” post major events like the election is a pattern that we have seen, as equities have historically delivered positive returns in the year following the presidential election (seen in Exhibit 1).

With the election now behind us, what is next for markets? We think there are three key things for investors to consider. First, investors can now focus on fundamentals, including economic and earnings growth, which are solid. Second, the “red sweep” will likely be supportive to both growth and earnings. And third, given the new direction of policy expected post the election, it might be a good time to revisit the 2016 “playbook”. We explore these points further in this week’s commentary.

Focus on economic and earnings fundamentals

On the back of an uncontested presidential race and continued Fed policy easing, investors can once again focus on key fundamentals, such as economic and earnings growth – both of which are solid.

Indeed, the Atlanta GDPNow is projecting 2.4% economic growth for the fourth quarter,² and growth is expected to remain above its trend rate in 2025.³ Further, if the Tax Cuts and Jobs Act (TCJA) is extended, and to a lesser degree there is a renewed focus on deregulation, growth could surprise to the upside, especially if tariffs are gradually phased in.

We also believe the Fed’s rate cutting cycle should continue to provide much needed rate relief to the economy, as we discussed here. Because manufacturing activity typically has an inverse correlation to interest rates, lower rates should support manufacturing. In addition, the Trump administration’s policies are likely to be focused on bringing production capabilities back to the U.S., which should also support manufacturing growth.

Earnings growth for the S&P 500 has also remained resilient. Currently, 75% of companies have reported earnings better than expectations, and in aggregate, earnings are coming in 4.3% above estimates.⁴ This trend is expected to continue as earnings expectations are $273 and $303 for 2025 and 2026, respectively.⁵ Together with a multiple of around 22x, this earnings growth should support further upside for the S&P 500, perhaps towards ~6,700 in 2025.

A (likely) full Red Sweep should further support economic growth, albeit with (tariff) caveats

It appears the election odds markets were correct to assign a higher probability of a red sweep. While we are still waiting on the results for the remaining 12 House of Representatives races, it appears Republicans will hold the executive and legislative branches of the government. Indeed, Polymarket currently assigns a 99% probability of Republicans controlling the House of Representatives.⁶ Assuming a red sweep, we think there will be three key focus areas under a second Trump administration, as we discussed in our recent Market Pulse, which can be found here. Two of them – taxes and deregulation – should support economic growth.

1. Taxes: We believe extending the provisions of the TCJA that are set to sunset at the end of 2025 will be a priority. Some of the key provisions we expect to be extended are current individual rates, the 20% deduction for business owners, an expanded child tax credit and higher exemptions on estate taxes.⁷ In addition, President-elect Trump has also proposed cutting the corporate rate to 15%. However, if Republicans do advocate for fiscal restraint, a large corporate tax cut is unlikely. If these tax cuts are passed as proposed, they could boost long-run GDP by 0.9%⁸ and boost S&P 500 earnings by 4.7%.⁹

2. Deregulation: There will likely be two key focus areas under a second Trump term. First, the administration will likely prioritize energy regulation relief. This would likely include easing regulatory hurdles to oil and gas development, expanding LNG exports and reversing restrictions on greenhouse gas emissions. Second, the administration will also likely focus on financial regulation. Indeed, a less stringent regulatory backdrop should improve the outlook for dealmaking and IPO activity. We could also see a rollback of proposed rules such as the Basel III endgame which would require banks to hold more capital. A recent study conducted by the Office of Management and Budget (OMB) suggested that new regulations cumulatively cost $16.1 billion for fiscal year 2023.¹⁰ However, another study conducted by the American Action Forum suggests that regulatory policies cost around $129 billion for calendar year 2023 – or 0.5% of GDP.¹¹

3. Tariffs: President-elect Trump has continually discussed a proposed 10% across-the-board tariff and a 60% tariff on all Chinese imports. But, unlike his first term, these tariffs may be enacted faster, especially if he uses executive orders. However, there are many variables that remain. Namely, will these tariffs be used as a negotiating tactic, or will they be gradually phased in? If these tariffs are enacted as proposed, they could reduce GDP growth by 0.7%¹² and S&P earnings by 5.2%.¹³ Importantly, tariffs are likely to come before taxes, which could create some market volatility to start next year.

Parallels and differences from 2016-2020 that investors could use

As discussed here, a Trump victory was expected to be favorable for sectors such as banks (specifically regional banks), reshoring beneficiaries (industrials) and companies with a high share of domestic revenue.

Looking at the initial market reaction, this seems to be playing out as regional banks are up 13.3%, onshoring beneficiaries are up 5.6% and companies with a high share of domestic revenue are up 3.6% since the election.¹⁴ Small caps, whose index has a high share of financial and domestically oriented stocks, are up 7.2%. Conversely, we have also seen clean energy names sell-off by -8.7% and China focused names are down -3.7%.¹⁵

If we look at how the markets reacted after the 2016 election, we think these trades could continue to perform well in the coming months. Indeed, after the 2016 election, we saw financials, onshoring beneficiaries, companies with high US revenue share and small caps outperform the S&P 500 (Exhibit 2).¹⁶

Outside of the equity markets, the bond market’s reaction has also been similar to what occurred in 2016.

Indeed, the U.S. 10-year Treasury yield was up 16 bps the morning after the election, which compares to a 20 bp move witnessed in 2016.¹⁷ While yields continued to climb higher after the 2016 election, there are some important differences to highlight between today’s environment and 2016.

First, rates were coming off a lower base in 2016, as the 10-year U.S. Treasury yield was 1.85% in the run up to the 2016 election, which compares to the 10-year U.S. Treasury yield at 4.28% heading into this year’s race.¹⁸

Second, the Fed was largely getting ready to resume its tightening cycle at the end of 2016, compared to today, when the Fed is expected to continue its easing cycle into 2025. Based on its dot plot, the Fed is projecting 100 bps of cuts by next year.¹⁹ Even with the futures markets pricing out approximately a full rate cut since the election, markets are still expecting the Fed to cut at least two times in 2025. So even if the new administration’s policies do put upward pressure on rates and inflation, the Fed still looks likely to continue the easing cycle into next year as it looks to return the policy rate to a more neutral setting – albeit it could be at a slower pace.

Third, there are still some Republicans who may advocate for fiscal restraint. Given the slim Republican majority that is expected in the House of Representatives, this could lead to a watering down of key proposals as Republicans make sure these policies have enough support. Currently, although it is estimated that extending the TCJA would cost roughly $4 trillion, Republicans will likely utilize tariffs and roll-back parts of the Inflation Reduction Act (IRA) to partially offset the cost.²⁰ Therefore, the enacted policy proposals under a second Trump term may not necessarily lead to the $7.75 trillion increase to the deficit that is being projected by the Committee for a Responsible Budget.²¹

Additionally, the 10-year U.S. Treasury yield is now more closely aligned with fair value estimates, indicating it is more reflective of the recent changes to both the policy and growth environment, which could also cap the upside move in yields.

Given the factors discussed above, the upside in yields may be more limited this time around. In fact, the current range of fair value estimates indicates the U.S. 10-year Treasury yield will likely trade in a range of 3.75% to 4.5% for not only the rest of this year, but also throughout 2025.

It’s Not Too Late to (Re)Position

What if you have not yet positioned for the red sweep? Despite the market’s sharp initial reaction, we don’t think it is too late to allocate to this outcome. Keep in mind, the policies of the incoming administration and Congress are likely to be the determinants of investment strategy over the next two and potentially four years. As a result, we would position thoughtfully and selectively, given the considerations below.

The markets are understandably cheering the prospect of no tax hikes or perhaps even tax cuts in 2025 and 2026 as well as a de-regulation mindset, which comes with the “red sweep”. And this exuberance may well extend into year-end, especially since it is hard to fight the seasonals right now.

While it has been an “everything rally” to date, investors should position according to President-elect Trump’s campaign promises, which prominently feature tariffs – on China, likely on autos from EU, and potentially, more broadly universal. As a result, we’d focus on domestic stocks over international, on cyclicals over defensives, and on the S&P 500 over the Nasdaq.