We are now close to 36 hours removed from perhaps the most shocking electoral outcome in U.S. history. Given the unexpected result—Republican Party control of government with Donald Trump in the White House—one might have thought the markets would react with sustained alarm. But they haven’t. Instead, following an initial swoon in U.S. equity futures, the stock market swung strongly positive during Wednesday’s trading session. Should this recovery and stabilization continue, it will serve as a reminder that presidential elections and political realignments generate headlines but rarely have a lasting material impact on financial markets.
Of course, that does not preclude the election from having created a distinct set of market winners and losers, at least on day one. The array of best- and worst-performing market segments gives us a window into what’s expected from Trump’s agenda. Starting with the winners, the U.S. dollar appreciated against emerging-market (EM) currencies, likely on speculation that President Trump’s hard-line rhetoric on trade deals may hurt EM economies. Within the U.S. equity market, pharmaceutical and bank stocks led the way. Tighter regulation of prescription drug prices and financial firms had been part of Hillary Clinton’s platform. Trump, if anything, may roll back existing restrictions on banks and, perhaps, energy companies. Industrials, another outperforming sector today, could benefit from increased business investment in the event Congress passes corporate tax reform or an infrastructure-heavy stimulus bill.
The biggest losers on Wednesday were assets with sensitivity to rising interest rates. In bond markets, this included longer-duration Treasury securities, with the bellwether 10-year yield surging to 2.06% from Tuesday’s close of 1.85%. In equity markets, high-dividend sectors like Utilities and Real Estate both fell more than 2% in Wednesday trading. Even gold, which rose sharply late Tuesday night, retraced all of its gains given its strong negative correlation with rates (when interest rates rise, gold prices tend to fall). Much of the move higher in rates seems to be due to perceived inflation risk, which may be tied to expectations of increased fiscal spending (i.e., budget deficit) next year. Supporting that point is the fact that markets have now priced in an 82% chance of a Federal Reserve rate hike next month, virtually unchanged from before vote.
Checking off these market segments and policy issues one by one, it’s not hard to see why investors might be optimistic about the possibility of a business-friendly agenda boosting corporate profits and/or economic growth in 2017 and beyond. Yet it’s possible that equities may struggle to move materially higher for some time given the untested and (let’s be honest) unconventional man voters have just elected to the presidency. Donald Trump, as president, may behave in unpredictable ways either in normal times or during periods of crisis should they arise. We won’t know for sure until he’s in office.
While it’s entirely possible that policies pursued in a Trump administration will have an impact, either positive or negative, on long-run economic growth or fiscal sustainability, such effects are as yet unknown and would likely be priced in gradually over time. By December, the markets’ attention will turn to meetings by the European Central Bank and the Fed, both of which must determine the direction of monetary policy. And by January, investors will be focused once again on corporate earnings reports, this time for fourth-quarter results. The occupant of the White House and the balance of political power clearly still matter in America, but they should not be the sole factors upon which investors base their decisions.
U.S. election has not created unusual market volatility
Equity market volatility, as measured by the VIX Index, has plunged to under 15% after reaching as high as 21.5% early Wednesday morning (11/9). Compared to the China growth scare that started the year and the Brexit vote in late June, November’s election was a minor event for U.S. stocks (see graph below). Even interest-rate volatility has been muted, despite the pronounced back up in Treasury yields on Wednesday.
Equity and bond market volatility indexes since mid-2014
Source: Bloomberg, as of 11/9/2016.
VIX: The VIX level measures market expectations of near-term volatility on the S&P 500 Index, conveyed by stock index option prices.
MOVE: The MOVE (Merrill Lynch Options Volatility Estimate) is a weighted index of implied volatility on 1-month Treasury options across the yield curve.