Investors have a challenge in betting on the usual stock market rally that tends to arrive after a presidential election: With the S&P 500 Index on track for one of its best-ever starts to a year, history cannot be a guide this time.
Buying US stocks into year-end following a vote is the classic trading playbook. Historically, the S&P 500 has posted a median return of 5 per cent from Election Day in November to the end of the year, according to data compiled by Deutsche Bank. Even the riskiest pockets such as small-capitalisation companies typically catch a bid in the rising tide.
But this is hardly a classic election year. The S&P 500 is up 25 per cent in 2024 after leaping 24 per cent in 2023, putting the index on pace for its first back-to-back yearly gains of more than 20 per cent since the late 1990s. As a result, share prices are high, with the S&P 500 trading at more than 22 times projected 12-month earnings, compared with an average reading of 18 in the last decade. And positioning data shows traders are already heavily invested in equities.
Meanwhile, familiar foes from the past few years – rising bond yields and the threat of persistent inflation – loom in the background. All of which has the stock market set up for a potentially quiet holiday season – as opposed to the ragers of election years past.
“With valuations elevated and the S&P 500 already near 6,000, the market will creep higher from here,” said Eric Beiley, executive managing director of wealth management at Steward Partners. “But I don’t see a big year-end rally because rising yields will keep investors at bay.”
The Federal Reserve has lowered interest rates twice since September. But recently, central bankers indicated that they are not in a hurry to go further.
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At the same time, Treasury yields have jumped to multi-month highs after US President-elect Donald Trump’s election victory ignited bets that his economic plans – such as large import tariffs and mass deportations of low-wage undocumented workers – could stoke inflation and hurt growth, possibly reducing the Fed’s scope to cut interest rates. This explains why Wall Street strategists have been dialling back their rate reduction expectations since Trump’s election victory.
The six months from November to April are historically the best part of the year for US equities because companies and pension plans tend to increase their stock buying starting on Nov 1, according to the Stock Trader’s Almanac. However, those year-end rallies typically are not as robust when the S&P 500 has already risen at least 20 per cent. In that case, since the 1970s, the average return from now to Dec 31 has been roughly 1 per cent, based on data compiled by Bloomberg.
Of course, this bull-market rally has gone far beyond these levels, with the S&P 500 up almost 70 per cent since bottoming in October 2022. That will curb gains into late December, said Savita Subramanian, head of US equity and quantitative strategy at Bank of America.
“Sentiment and positioning based on at least five indicators have grown dangerously bullish, leaving less room for positive surprises,” she wrote in a note to clients on Nov 15.
Already, some of the riskiest parts of the market are showing signs of weakness. Small-cap stocks, for instance, have erased most of their post-election rally as concern grows about the Fed’s rate path. And uncertainty over higher borrowing costs is prompting investors to hedge against sharp declines. Demand for far out-of-the-money put options on the S&P 500, technology-heavy Nasdaq 100 Index and small-cap Russell 2000 Index has risen to levels last seen during the heavy volatility ahead of the election, said Kevin Brocks of 22V Research.
That said, the rally is not necessarily in jeopardy simply because there is growing speculation that the market has run too far. Valuations and investor sentiment can stay frothy for weeks – even months – before stocks suffer a significant drop, said Max Kettner, chief multi-asset strategist at HSBC Bank, adding that there are “very few reasons to suggest a year-end rally has already been front-loaded”.
Indeed, investors keep funnelling money into stocks: They put US$16.4 billion into US equities in the week until Nov 20 inclusive, marking the seventh consecutive weekly inflow, a Bank of America note citing EPFR Global data showed.
The optimism is not entirely surprising. Looking at history, the S&P 500’s advance over the past two years is not even half of the 143 per cent average gain in the 16 prior bull runs since 1945, according to Birinyi Associates.
What investors most want to see when judging the rally’s strength is the gains broadening beyond the mega-cap tech stocks that have been powering indices higher on enthusiasm for artificial intelligence. It is starting to happen, as the S&P 500 Equal Weight Index is outperforming the regular market-cap weighted version of the benchmark since Election Day, with financials, energy and consumer discretionary shares leading the way.
In the end, however, it may be the bond market that sends the loudest signal for stock prices. If Treasury yields stay high and the Fed stands pat, there are serious risks to betting on significant further gains in equities.
“A broadening rally is crucial but the one thing standing in the way of a strong advance for stocks the rest of the year is the bond market,” said Jamie Cox, managing partner at Harris Financial Group. “That may ultimately put a lid on a hefty year-end rally.” BLOOMBERG
