Week 48

Macro

Investor macro analysis is heavily influenced by U.S. politics, centered on the presidential transition and cabinet appointments. Concerns persist over potential destabilization stemming from efforts to “dismantle the deep state,” which includes the intelligence community, defense establishment, and broader bureaucracy. However, optimism surrounds the prospects of deregulation and reduced government intervention, which could enhance efficiency and improve fiscal discipline. Resolving international conflicts is also a priority, with potential to bolster geopolitical stability and mitigate risks to financial markets.

President-elect Trump has moved quickly to announce key cabinet nominations, including market-friendly picks such as Scott Bessent (Treasury) and Kevin Hassett (National Economic Council). These appointments aim to reassure financial markets but are accompanied by controversial pledges, such as imposing tariffs of 25–35% on imports from Canada, Mexico, and China. The tariff proposals have already triggered temporary sell-offs in the Canadian dollar and Mexican peso, raising concerns about disruptions to global trade and market stability. These tariffs risk dismantling NAFTA, while posing a challenge to the foreign policy, such as resolving conflicts in Ukraine and the Middle East, face significant challenges. In Ukraine, U.S. sanctions have intensified pressure on Russia’s economy, with the ruble falling to a 32-month low and inflation exceeding 20%. In the Middle East, Trump’s strong pro-Israel stance signals a continuation, if not an escalation, of current U.S. policies.

Libertarian economists are optimistic about the administration’s plans to reduce government spending, viewing it as a potential driver of long-term economic growth. They argue that government spending is often an inefficient use of capital and that reducing it could free up resources for private sector investment, which is typically more productive and efficient, thereby enhancing economic output over time.

In Europe, the economic outlook remains mixed. While Eurozone economic sentiment showed slight improvement, inflation climbed to 2.3%, with core inflation at 2.7%, complicating the European Central Bank’s monetary easing efforts. German business confidence weakened, but French GDP growth offered a modest positive. Meanwhile, the Reserve Bank of New Zealand and the Bank of Korea both cut rates, citing inflationary and export concerns. In contrast, speculation is mounting that the Bank of Japan may hike rates in December following unexpectedly strong Tokyo CPI data.

In the UK, the Bank of England issued a stark warning about rising risks to the financial system. Its report highlighted potential threats from a looming trade war, geopolitical instability, and increasing government debt, which could disrupt cross-border capital flows and trigger a market correction. Risks are particularly elevated in the sterling corporate bond and gilt repo markets. While these vulnerabilities are not new, the BoE emphasized that a specific catalyst may be required to bring them to a breaking point.

Investors are turning their attention to upcoming central bank meetings and critical economic data releases, including U.S. non-farm payrolls and global PMIs, which are expected to shape monetary policy heading into 2025. Ongoing uncertainties around trade policies and geopolitical tensions remain key factors influencing market sentiment.

Rates

U.S. Treasury yields were mixed this week, reflecting the ongoing interplay of tax policy expectations, inflation concerns, and growth projections. After spiking 10 basis points on election day due to optimism around proposed tax cuts, 10-year yields declined by 10 basis points, ending at 4.19%. Short-term 2-year yields rose slightly by 2 basis points, indicating persistent concerns about near-term growth and inflation.

The yield curve steepened as longer-term rates (from 1 year onwards) moved higher, particularly at the curve’s belly, while ultra-short-term rates (less than 1 year) edged lower. This divergence reflects the market’s adjustment to mixed signals, including improving growth expectations and the GOP’s fiscal agenda, which has raised fears of heightened deficits and higher term premiums.

The Federal Reserve’s recent rate cuts—initiated just seven weeks before the election, marking the shortest pre-election cycle in history—have provided immediate relief however strong economic growth and continuous inflationary pressure signalled a potentially prolonged easing cycle. This adjustment suggests a steadier path for monetary easing and sustained support for equities.

As the Federal Reserve signals a potential pause in rate hikes for December, investors remain cautious. They balance growth optimism with fiscal risks, which are likely to continue shaping the trajectory of yields in the weeks ahead.

Credit

U.S. corporate credit spreads remained steady this week, reflecting investor confidence, bolstered in part by market-friendly cabinet nominations from President-elect Trump. However, concerns persist over proposed tariffs of 25–35% on imports from Canada, Mexico, and China, which could disrupt global trade and weigh on corporate profitability. High-yield markets saw moderate inflows, supported by expectations of a prolonged Federal Reserve rate-cut cycle, which could provide a buffer for lower-rated issuers.

Corporate profitability has remained relatively stable, bolstering firms’ debt servicing capacities. However, vulnerabilities persist, particularly among highly leveraged companies facing refinancing challenges in a higher interest rate environment. The 5-year US CDS is stood around 29 bps indicating no changes to sovereign credit risk.

Macroeconomic surprises have applied upward pressure on yields, while the dollar index rose 1.8% during the week, exacerbating headwinds for corporate earnings by increasing the cost of dollar-denominated debt and reducing export competitiveness.

Investment-grade corporate bond ETFs, such as the iShares iBoxx USD Investment Grade Corporate Bond ETF (LQD), exhibited minimal changes, indicating stability in higher-quality credit markets. In contrast, high-yield bond ETFs, including the iShares iBoxx USD High Yield Corporate Bond ETF (HYG), experienced slight declines, signaling cautious sentiment among investors toward riskier debt.

Equities

These policy expectations have propelled U.S. equity markets to new heights, with the S&P 500 climbing 5.3% since election day. The S&P is up over 31% this year, setting up 2024 to be another blockbuster year. This will set the bar high for 2024, and we might expect more reasonable returns in the 0-10% range. Also, big tech valuations might be challenged, offering more room to grow for smaller companies.

Small-cap stocks drove this week’s performance, with Russell 2000 being the standout performer, posting its largest monthly gain since December 2023. Regional banks (+14.5%) and money-center names like Bank of America (+13.6%) and JPMorgan (+12.5%) led the financials rally. Credit card issuers, including Discover (+22.9%) and Capital One (+18.0%), also posted strong gains. Government-sponsored enterprises Fannie Mae (+125.2%) and Freddie Mac (+140.3%) rallied on renewed privatization hopes.

Industrials saw broad-based gains, particularly in machinery (Deere +15.1%) and airlines (United Airlines +23.7%). Consumer discretionary was a standout sector (+13.2%), with Tesla (+38.2%) benefiting from Elon Musk’s ties to the Trump administration and Amazon (+11.5%) rallying after an operating income beat. Retailers (+10.5%) and homebuilders (+7.6%) also supported the sector’s performance.

While parts of the tech sector lagged due to the rotation into pro-Trump trades, software names like Salesforce (+13.3%) and Oracle (+10.1%) performed well. Semiconductors (-0.4%) capped broader tech upside. In materials, aluminium stocks (+15.8%) outperformed, but copper miners (-1.8%) and global mining firms (-5.1%) faced headwinds.

Healthcare lagged, with pharmaceuticals (-4.2%) and hospitals (-8.8%) pulling the sector lower. Precious metals miners (-6.6%) and chemicals (-10.5%) in materials also underperformed. Energy matched market gains despite sluggish oil prices, while utilities (+3.2%) and REITs (+4.0%) posted modest advances.

In November 2024, U.S. equity funds saw record inflows totalling $140 billion. The decisive election outcome bolstered market sentiment, leading to an unwinding of downside hedges and triggering systematic fund buying. Rally reflects investor optimism following the U.S. presidential election, driven by expectations of pro-growth policies under President-elect Donald Trump. These policy expectations have propelled U.S. equity markets to new heights, with the S&P 500 climbing 5.3% since election day. Traders are optimistic about robust economic growth, corporate earnings, and improved household cash balances, which could sustain the influx of funds into equity markets into 2025. Key factors include proposed tax cuts, deregulation efforts, and “market-friendly” appointments such as financier Scott Bessent as Treasury Secretary. Equities are further supported by the prospect of a GOP-led corporate tax cut, which is estimated that it could lift earnings by 4-5%.

A major catalyst for the market’s upward trajectory over the past 18 months has been the easing of financial conditions. Since September 2022, the U.S. Financial Conditions Index has steadily declined, facilitating an expansion in equity valuations. However, with the index now hovering around 95, some argue that financial conditions have reached their peak of accommodation. The Federal Reserve’s rate cuts have bolstered the so-called “Fed put.” At the same time, post-election dynamics have introduced a “Trump put,” with pro-business cabinet proposals and bullish rhetoric sparking renewed “animal spirits” among investors.

While financial conditions remain supportive, strengthening the dollar adds more pressure on corporate earnings. A 1% appreciation in the U.S. dollar typically shaves 50 basis points off S&P 500 earnings, posing a headwind if the dollar strengthens. Additionally, if inflation accelerates, it could complicate the outlook for monetary policy and corporate earnings.

Other concerns are over-stretched valuations and rising bond yields, which can temper the rally. The S&P 500 ended the month with a trailing P/E ratio exceeding 26x, the fourth-highest in over a century, highlighting valuation risks. U.S. equities also traded at a record 60% premium to the MSCI World ex-US index, further emphasizing the market’s elevated positioning.

Historical patterns suggest further upside potential. In years when the market rose over 10%, and it was an election year, December has consistently delivered positive returns with a 100% success rate. However, stretched valuations and potential headwinds from inflation or dollar strength could temper this outlook.

Macro data have been stronger than expected, and growth fears that investors had over this year have diminished, yet there is still $6t in money market funds waiting to be allocated. Margin debt has not risen much in the past four months, while the stock market is up. This divergence means that investors have been more cautious and did not add much equity risk.