With the Republican party poised to clinch control of
the White House and Congress, our CIO and Chief US Equity
Strategist says markets are readying for a lighter regulatory
environment, supportive tax policy and a possible rebound in
investor enthusiasm.
----- Transcript -----
Welcome to Thoughts on the Market. I'm Mike Wilson, Morgan
Stanley’s CIO and Chief US Equity Strategist. Today on the
podcast I'll be talking about the results of last week’s election
and its impact on equity markets.
It's Monday, Nov 11th at 11:30am in New York.
So let’s get after it.
Our work leading up to the election showed that stocks likely to
benefit from a Republican sweep did not actually see
material outperformance up and through November 5th. In other
words, this political outcome was not fully priced. As a result,
this allowed for significant outperformance of Financials,
Industrials, and other cyclicals last week. We see further follow
through to the upside in quality cyclicals as prospects for a
lighter regulatory environment, supportive tax policy and a
potential rebound in animal spirits should rise following
the election outcome. These developments came on the back of a
macro backdrop that was already becoming more supportive of
cyclical outperformance – and why we upgraded this cohort to
overweight in early October. We continue to be sellers though of
tariff-exposed consumer stocks and renewable energy
stocks.
Our upgrade to Financials in early October was rooted in our view
that expectations were low going into earnings season while
positioning remained light. Our work since then showed
that the majority of the group's outperformance into the
election could be explained by strong earnings revisions as
opposed to rising odds of a Trump win in prediction markets. Now
that we have the election results in hand, it appears that
expectations for de-regulation are also driving performance
upside in addition to improving fundamentals.
While the 2016 playbook would suggest small caps and lower
quality equities could see a period of outperformance
following the election, there are a couple of important
differences worth considering. First, several of these areas
of the market are exhibiting a negative correlation
to interest rates today whereas they were showing a positive
correlation in 2016. In other words, in today's later cycle
environment, these cohorts' adverse sensitivity to rising rates
is greater than it was in that period. Should rates see more
upside post the election, there is likely less upside this
time for small caps and lower quality cyclicals. Furthermore,
relative earnings revisions breadth for small cap cyclicals
is negative today, whereas it was positive in 2016. Finally, even
with the increase in animal spirits following the 2016 election,
small caps' relative performance peaked in early December of that
year, just one month after the election.
While the momentum remains to the upside for US equity markets
led by quality cyclicals, it's worth considering the
potential risks. The first one is a material move higher in
interest rates driven by a rising term premium. The 50 basis
point rise in term premium so far has not been enough to
worry equity investors yet. However, should the term premium
accelerate materially from here driven by fiscal sustainability
concerns, equity valuations would likely face headwinds. Second,
one of the more popular views in the macro community is for a
stronger dollar. If such strength continues into year-end,
it could provide a headwind to multinationals' Earnings growth
for 2024 and 2025.
A final risk to the positive price momentum is simply price
itself. Over the past several months, the price change of the
S&P 500 has distanced itself from the fundamentals. More
specifically, the year-over-year change in the S&P has
rarely been this disconnected from earnings revision breadth
and business confidence surveys. However, given the positive
reaction to the election so far in markets and from many
business leaders, perhaps animal spirits can take earnings
guidance higher – which is necessary to maintain the current
trajectory in equity markets, especially since that is now
expected by stock prices.
Thanks for listening. If you enjoy the podcast, leave us a review
wherever you listen, and share Thoughts on the Market with a
friend or colleague today.
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