With investors eyes focused on the US elections, the markets took a breather in October, posting 23 days without a daily change of more than 1%, the first time this has happened in three years. Once again, the polls underestimated the likelihood of Donald Trump's return to office; however, this was not the case for the financial markets, which correctly priced the result.
Some sectors sensitive to Donald Trump's economic programme climbed between October and the eve of the election, such as banking (+7.4%), technology (+3.7%) and consumer discretionary (+4%). Conversely, other sectors favoured by a Kamala Harris election had already come under pressure, such as renewable energies, with the iShares Global Clean Energy ETF shedding almost -11% in October. A rally in the sectors supported by the Republican's programme got underway immediately after the election, and small and medium-sized companies posted their biggest weekly gain for 24 years, with the Russell 2000 up 8.6%, anticipating a major impact from the tax cuts.
However, after a few months of sector euphoria, economic reality is likely to take over from the direction of the financial markets. In the long term, history shows that the political slogans of both camps have little impact on the performance of asset classes, as no US president has seen a fall in the flagship index since 1945, with the exception of George W. Bush (who experienced both the dot com crisis of 2000 and the financial crisis of 2008).
The US market remains well positioned to continue its domination over European markets, which has been underway since the end of the financial crisis. This is despite the fifty all-time highs reached by the S&P500 index since the start of the year, high valuations and the highest level of equity ownership among US households since the tech bubble of 2000. Trump is likely to reinforce, what is commonly referred to as "American exceptionalism": low taxes, a laissez-faire approach to business, citizens who are eager to consume and save little, and a government concerned with growth.
In fact, no European market sector has managed to outperform their American peers since 2010. This underlines the capacity of US companies to innovate, generate profits and grow margins, supported by an expansionary policy that does not measure spending and regulates less. Another fact remains, the American consumer continues to consume and has greater confidence in the economy, despite a 30-year mortgage rate of 7% and credit card debit rates of 17%. Their European cousin, on the other hand, is saving more out of fear of the future, and doubts its ability to maintain its purchasing power.
At this stage, there is little to indicate a reversal in the trend favouring U.S. equities in the coming years. Especially under a Republican presidency, with the “trifecta” of a majority in both the Senate and the House of Representatives, allowing for the implementation of promised economic policies.
European markets, meanwhile, are struggling to find their feet. Weak growth, despite a slight rebound in manufacturing activity in September, points to an acceleration in the pace of interest-rate cuts in order to revive the economy. Over and above the economic headwinds in Europe (exposure to Chinese demand at half mast, polarisation towards traditional industry, cuts in government spending), the political risk remains high, in France still with the difficult subject of the 2025 budget, but also in Germany, where the government is likely to call by-elections, the outcome of which is uncertain.
Market expectations of a 15% growth in US corporate profits by 2025 remain very high. Indeed, the publication of third-quarter earnings has set a strong trend that makes this objective entirely achievable. With more than 90% of companies having published their results, they exceeded earnings expectations by 6.5% compared with an average of 4.8% since 2019, resulting in growth of 7% compared with 4% expected at the start of the season. 68% of companies earnings surprised positively versus expectations, compared with 59% historically. In Europe, 70% of companies have reported at this stage, with earnings 4.8% ahead of expectations, resulting in zero year-on-year growth, better than the -1% expected at the start of the season but reflecting continued weakness relative to US companies. In addition, the likely adoption of favourable tax measures across the Atlantic is boosting forecasts, notably the extension of the Tax Cuts & Jobs Act, which alone could inject almost $5,000 billion into the US economy by 2035, or practically 2% more GDP every year!
On the interest rate front, the yield curve steepened further, with Donald Trump's programme of major additional budget spending in the spotlight. The 10-year US Treasury yield approached 4.5% in the immediate aftermath of the election, against a backdrop where interest on debt exceeds 3.5% of GDP, double that of the most indebted European countries. That said, the markets' appetite for US debt is not waning, as illustrated by the US Treasury, which managed to issue 25 billion of 30-year debt at 4.60% the day after the election, i.e. 3bps below market levels.
The recent dichotomy between rate cut expectations in the US and Europe is justified by diverging growth and inflation trajectories. This should prompt the Federal Reserve (Fed) to slow its easing cycle with three or even four further rate cuts between now and the end of 2025, while the European Central Bank (ECB) is likely to maintain its forecast of more than five or six rate cuts. This reduction in expectations of rate cuts in the United States does not mean, however, that the US market will lose momentum in the short term in a soft landing scenario. In 1995, after a 23% return on equity markets, the Fed cut rates by just 75bps, and the market returned another 23% the following year, albeit at valuations twice as low as they are now.
For its part, China took advantage of the election result and the prospect of difficult negotiations with the United States to add 1,400 billion in support for its local authorities. That said, trade disputes and tariff wars can also reshape sector performance. Witness the memory of 2018-2019, when in the midst of a trade war and rising import taxes, utilities, telecoms, property, consumer and healthcare performed well in the US to the detriment of semiconductors, technology equipment and autos, as well as Chinese equities as a whole.
The financial markets are therefore set for an interesting end to the year, in a period that is statistically very buoyant for equities ahead of Donald Trump's inauguration on 20th January 2025. We are maintaining our overweight position in US equities.