Former President Trump survived an assassination attempt by a gunman over the weekend. While obviously a troubling event regardless of political affiliation or preference, the market impact of it should be relatively limited for two reasons. First, the market already assumes a Trump victory and potential Republican sweep in the November elections, and the events of the weekend do not reduce those chances. Second, the ultimate direction of this market will still be determined by economic growth and whether there’s a material economic slowdown or not, and the events of the weekend won’t impact growth one way or the other.
Stocks continued to climb to new record highs last week, but a significant uptick in volatility as a rotation away from mega-cap tech and towards the “rest of the market” was sparked by cool inflation data late in the week. The S&P 500 gained 0.87% on the week and is now up 17.73% YTD. Equity markets were quiet to start last week, and last Monday, there was no notable economic data, and investors looked ahead to Powell’s testimony last Tuesday.
The S&P 500 rose 0.10%. The market continued to inch higher on Tuesday as Powell did not offer any surprises on his first day of testimony on Capitol Hill, continuing to reiterate that growth and inflation risks are coming into balance. The S&P 500 edged up another 0.07% on the day amid a steady bond market and market focus increasingly turning to CPI. Stocks lurched higher on Wednesday as Powell’s testimony concluded without any material changes in tone or developments that would impact policy expectations, while macroeconomic news flow remained notably quiet.
The S&P 500 hit yet another new high last week (the 36th of 2024!) as stocks continued to ride a wave of optimism surrounding three main events: 1) Impending Fed rate cuts, 2) Continued disinflation (decline in inflation) and 3) Expectations for a Republican sweep in the November election. The “good” scenario of each of those events has been instrumental in sending the S&P 500 through 5,600, and rightly so. Fed rate cuts will reduce pressure on the economy, likely reducing the chances of a hard landing. Disinflation will ease the “inflation tax” being paid by consumers, helping to make consumer spending (which is the critical part of the economy) more resilient. And finally, if Republicans sweep, the Trump tax cuts will be extended, and a more pro-business regime will take total power.
All of those outcomes are positive, and expectations of them have rightly pushed stocks higher. However, there are negative outcomes from these events as well, and while I am not going to say they are likely, it is a mistake for investors to simply assume there is no potential drawback to these events because there is a negative consequence for each of these. First, Fed rate cuts will reduce the headwind on the economy, but it’s the “why” that matters. Is the Fed cutting rates because growth is slowing more than they anticipated? Slowing growth can be a major negative for markets, and despite investor enthusiasm, rate cuts are not a guaranteed market-positive event. Second, disinflation does reduce headwinds on consumer spending. However, it can also reduce corporate earnings. The pandemic inflation has been a boon to S&P 500 earnings, as well-heeled consumers simply digested the price increases, boosting both revenue and margins across industries! However, inflation is now falling because 1) Supply chains have normalized and 2) Because the consumer is pulling back (less demand). Falling prices can compress margins and reduce revenue, and we’ve seen evidence of that occurring across earnings recently (NKE and WBA a few weeks ago, DAL/CAG/PEP last week). Disinflation is a macroeconomic good, but it can also place downward pressure on earnings, which would be a negative for market valuations.
Finally, whether it’s historically accurate (the jury is out based on index performance) markets think Republican governments are positive for stock prices and ever since Biden’s poor debate showing, markets have been increasing expectations for a Trump win and a Republican sweep of the House and Senate. However, Trump is not a typical Republican. His stated tariff agenda risks a new trade war that will have unintended and unknown consequences (which could be bad).
Additionally, debts and deficits will matter in the coming years. The Trump tax cuts may be extended if Republicans win, but if global bond markets don’t see moves by the government to address the U.S. fiscal situation, Treasury yields could rise despite slowing growth, creating a vise for consumers and companies. Fed rate cuts, falling inflation and a Republican sweep are probably good for stock prices and the economy. But they are not a guaranteed good (and they could, in fact, be bad).
I am not trying to confuse you, but the picture is never clear or absolutely predictable. It is about probabilities. For now, there is a 90% probability that the markets will end the year higher than current markets. I will keep you updated on that probability as it changes. Stay positive while we ride this wave.
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