3 takeaways on the market's big moves
What investors might be getting right—and wrong.
- Last week's election results might have resolved a degree of policy uncertainty, which sparked the market rally, though other uncertainties remain.
- While many investors feel a recent rise in long-term interest rates is related to fiscal policy, it might instead be explained by economic growth.
- Small caps and financials already had a potentially attractive setup. Policies of the incoming administration could provide a slight additional benefit.
The market has had a lot of news to digest since Election Day, and investors have been watching that happen in real time—with big moves occurring in a range of investment types.
At the same time, rumors and theories have been swirling as to why the market has been making these moves.
The “why” behind market moves matters, and the current moment is no exception. Read on to learn more of what history can tell us about the market’s prospects from here, and 2 top picks for market segments with particularly strong potential setups.
1. Why did the market rise last week?
Markets are nonpartisan. They have no bias or favoritism for one party or candidate versus another. And election results have not historically been notable market drivers.
Yet the market rose last week after election results. Is this a contradiction?
Not necessarily. Remember that markets strongly dislike uncertainty. Many Americans were expecting a long wait for election results, and expecting that the outcome might rest on razor-thin margins. But instead, results came in quickly and decisively for the presidency and Senate.
Clear results brought a swift resolution to some areas of policy uncertainty. Under a Harris administration, the market was likely to face greater uncertainty over tax policy—particularly corporate tax rates. Instead, under a second Trump administration, the focus may be on uncertainty over tariff policy.
The election didn’t resolve all uncertainty, but it seemed to take one group of uncertainties, around potential tax hikes, off the table. That sense of resolution might be the real driver behind that positive market reaction.
2. Is the bond market sending a warning signal?
Another area of much chatter has been the movement in long-term interest rates.
Some investors seem worried by the fact that even though the Fed has been cutting rates, long-term interest rates, like the 10-year Treasury rate, have been rising. (The Fed’s policy rate, the fed funds rate, is for very short-term loans. Rates on longer-term forms of debt are determined by market forces.)
Past performance is no guarantee of future results. Effective federal funds rate is a proxy for the target range for the federal funds rate, and is calculated as a volume-weighted median of overnight federal funds transactions reported to the Federal Reserve. Sources: FactSet, Federal Reserve Bank of St. Louis. Data from Jan. 1, 2024, to Nov. 12, 2024.
Investors seem to have concerns about both the causes and effects of this rate movement. In terms of the effects, investors may be worrying that higher borrowing costs on long-term loans could, in a sense, undo the positive effects of the Fed’s rate cuts—putting a drag on the economy and creating a headwind for stocks. As for the causes, one prevailing explanation is that the market is worried about the prospect of rising deficits, and the inflationary impacts this could have.
Market history may help to assuage worries about the effects; specifically looking at market performance in periods since 1962 when the Fed has been cutting rates. While past performance is no guarantee of future results, when the 10-year Treasury yield has also been rising (rather than falling, as is more common), the S&P 500® has actually delivered better returns.
How does this make any sense? Because in the vast majority of times when long-term rates are moving higher, growth is better too. And that looks to be the situation we find ourselves in today, based on both earnings growth and on increases in indexes of leading economic indicators (leading economic indicators are data points that tend to inflect before an inflection in the broader economy). Growth, not rates, tends to be the decisive factor for the stock market.
This is also relevant to the “why” behind the rise in rates. People may disagree on why 10-year rates have been rising recently, and causation versus mere correlation can be challenging to distinguish in real time. But this might be explained by an uptick in leading economic indicators that has occurred at the same time.
Rates are often a reflection of growth. Higher rates on longer-term forms of debt might simply mean the market is expecting higher growth rates over longer periods. And if that is the case, the outlook for stocks may be quite bright. After similar historical periods since 1962—meaning periods when the Fed has cut, 10-year rates have risen, and leading economic indicators have also been rising—the S&P has risen in 97% of subsequent 12-month periods. (Though again, past performance is no guarantee of future results.)
3. What investments might benefit from upcoming policy changes?
The market is forward looking. Now that investors know who will be taking the oath of office in January, they’re already looking ahead to which sectors and segments could be impacted by policy changes from the next administration.
Although policies do matter, history has shown that making investing bets on policy has often not paid off. Investors who bet against health care in the mid-1990s, when health care reform was in the news, would have missed out on the market’s best-performing sector over the following decade. Investors who bet on clean energy stocks as a winner of Biden-administration priorities have been similarly disappointed in recent years.
Why is this so often the case? Frequently it’s due to valuations. Stocks often price in good or bad news well in advance—sometimes becoming too cheap, or too expensive, relative to the policy impacts. Also, policy is often not the critical driver, so investors who focus too much on policy changes may miss the more important tailwinds or headwinds.
All of that said, there are 2 segments right now that already offered attractive setups, and where policies might provide a slight additional boost: small caps and financials.
Small caps have been lagging badly for years as investors have favored mega-cap tech stocks. Small caps tend to be more sensitive to economic growth than large caps—a potential advantage in the current period of positive-growth surprises—and more sensitive to a falling fed funds rate. The stocks also reflect a high degree of investor fear, which I measure by looking at valuation spreads, meaning the difference between the most expensive and least expensive stocks (i.e., the difference between the highest and lowest price-earnings ratios). This would paint an attractive picture no matter how the election had turned out. But small caps also tend to be more sensitive to changes in corporate tax rates than large companies, so they could also stand to benefit more from the reduction in corporate-tax policy uncertainty.
Financial stocks have shown a similar setup. The stocks have been quite cheap. And while cheapness doesn’t predict outperformance in all sectors, for financials it typically has. Like small caps, the sector has been reflecting a high degree of investor fear. Again, this already looked like a potentially attractive picture—but the possibility of lighter regulations on issues such as bank capital requirements, under the incoming administration, might add to the attractiveness.
Both of these market segments saw a boost in the past week, but some believe they could have further to go.
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