By Jacob Sonenshine
The stock market is soaring after the election -- and the easy money has been made. Don't expect these types of gains to continue.
The S&P 500 is up just over 2% Tuesday, while the Nasdaq Composite has gained over 2% and the Dow Jones Industrial Average is up just over 3%. Former President Donald Trump won the presidential election, and Republicans look to have taken the majority of seats by a slim margin in the Senate.
This means Trump's fiscal spending policies have a good chance of passing, especially if the Republican party clinches a majority in the House of Representatives. They include cutting individual tax rates for several brackets and getting rid of taxes on social security income, essentially putting extra spending money in peoples' pockets. That's why some consumer stocks are outperforming the indexes, but it's also why some U.S. manufacturing stocks are up more than 2% in aggregate. Companies would have to make more materials and machines to meet demand.
The red wave also means taxes on companies who produce goods at home are likely to go down, toward 15% from 21%. Simply reducing a tax rate by that much would lift earnings by just over 7%, Barron's calculates, but many companies on the major indexes source tons of materials and products from overseas, so the aggregate profit boost wouldn't be quite so high.
So the market has now already reflected potentially higher corporate earnings. The S&P 500 is trading at almost 22 times expected earnings for the coming 12 months. That's at the high end of the range in the past three years, and investment strategists at Ned David Research called the index overvalued in a recent note.
Valuations, however, are ignoring the rise in the 10-year Treasury yield to just over 4.4%, its highest level since the middle of the summer. Such a yield -- for a risk-free investment -- is extremely competitive versus potential returns in stocks. The S&P 500's 22 times earnings multiple means that, for every dollar put into in the index, an investor receives 4.5% from the earnings in return -- which isn't much additional compensation for the risk of being in stocks. Historically, stocks have looked much more attractive versus bonds than that.
The point is that it's now easy to envision more muted moves in stocks beyond Tuesday's trading -- and there's plenty of risk for setbacks as certain policies unfold.
"We are inclined to lighten into a material move," writes Citi strategist Scott Chronert, meaning that investors should hold off on aggressively buying shares after this rally.
First off, the market has to see how much fiscal spending will pass, and Trump won't even take office until January. Undoubtedly, tax cuts will spur more spending, but the degree of that boost remains a question.
Secondly, the Federal Reserve may not cut interest rates as quickly as previously anticipated. Still-high rates may eventually hold back economic growth beyond the short term.
Thirdly, tariffs would offset economic strength from tax cuts. Trump can implement much of his tariff agenda -- which includes possibly 60% tariffs on Chinese goods and 10% on other imports -- without consulting Congress. In time, he will likely succeed in imposing them in one form or another. This would lift U.S. companies' costs and force many of them to, in turn, lift the price of the goods they sell, adding a burden to the American consumer. Eventually, this would hold back consumer demand.
"Our ongoing concern is that a Trump push down the tariff path may distort forward growth expectations," Chronert writes.
Stocks are partying in the aftermath of the election. Now comes the challenging part for investors.
Write to Jacob Sonenshine at jacob.sonenshine@barrons.com
This content was created by Barron's, which is operated by Dow Jones & Co. Barron's is published independently from Dow Jones Newswires and The Wall Street Journal.
(END) Dow Jones Newswires
November 06, 2024 14:06 ET (19:06 GMT)
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