Trump Trade-Driven Stock Rally Nearly Erased

TradingKey - The S&P 500 rose 5.3% from November 5 (Election Day) to its peak on December 6. However, the index has since fallen more than 4% from its record high, signaling that the post-election "Trump trade" frenzy has nearly evaporated. 

Historically, U.S. stock markets have seen significant gains between Election Day and Inauguration Day. For example, following Donald Trump’s surprise victory in 2016, the S&P 500 rose 6.2% during this period. 

Source: Dow Jones

Why does the market behave differently this time?

In 2016, Trump’s unexpected win over Hillary Clinton fueled optimism among investors, who bet on industries and sectors expected to benefit from his proposed policies. This optimism drove a strong market rally.

This time, many believed that Trump’s tax cut proposals could boost his reelection chances, and initially, the market responded accordingly. On November 6, the day after the election, the S&P 500 opened higher and continued its pre-election rally.

The ongoing sell-off in the U.S. Treasuries has emerged as a key driver behind the decline in U.S. equities. Growing concerns about persistent inflation in the U.S. have led to fears that the Federal Reserve may need to scale back its planned rate cuts this year to combat rising prices. These concerns were further intensified by last Friday’s unexpectedly strong employment data. The sell-off in Treasuries has pushed U.S. Treasury yields sharply higher, and rising yields and rising equity prices rarely occur simultaneously.

Higher Treasury yields increase borrowing costs across the economy and raise the risk-free returns investors can earn by holding Treasuries to maturity, putting pressure on equities. As these safer returns rise, riskier assets like stocks appear increasingly expensive.

The 20-year Treasury yield has consistently stayed above 5%, while the 30-year yield breached this key level last Friday before dipping slightly below it. Meanwhile, the policy-sensitive 10-year Treasury yield is also trending toward 5%. A 10-year yield at 5% has alarmed markets, as it represents the upper limit of interest rates over the past 20 years.

Another key factor differentiating the current stock market environment from 2017, when Trump first took office, is the elevated valuations.  

Following two consecutive years of gains exceeding 20%, the S&P 500 has surged more than 50% since the end of 2022. In 2023, the index set over 50 record highs. This stands in stark contrast to Trump’s first term, during which the S&P 500 rose just 9.5% in 2016 and only 8.5% in the two years preceding his presidency.  

Currently, based on Alan Greenspan’s valuation model, U.S. stock valuations have climbed to their highest levels since 2002. While equity yields remain higher than bond yields, the gap has narrowed significantly, suggesting that stock valuations are stretched relative to historical norms. This brings valuations closer to the levels seen in 1996, when Greenspan famously warned of "irrational exuberance."