Stocks surged last week, with each of the three major indices closing at new record highs. Much of the strong performance was driven by expectations that a second Trump administration would loosen regulation of businesses, possibly lower corporate taxes and pursue what are widely believed to be pro-growth policies, which investors expect would result in a broadening of economic growth. Importantly, the potential for a broadening of economic strength benefited a wide swath of the market, including U.S. Small and Mid-Cap stocks—two areas of the market we have identified as historically cheap relative to their Large-Cap counterparts. Indeed, Small Cap stocks outpaced Large Caps for the week, and stocks in most industries rallied. At the same time, bond yields initially rose in the aftermath of the election (yields move inversely to price), possibly signaling not only expectations of stronger growth but also the potential that tariffs and tighter immigration may provide a counterbalance and could serve to push inflation and interest rates higher in the intermediate and long term than previously expected. However, likely reflecting the unknown details of any such proposals coupled with their uncertain impact on overall economic dynamics, interest rates pulled back to end the week. The temptation to make large bets in the markets after a major election can be strong, but as we’ve consistently noted, there are risks in doing so. Broad priorities and economic goals of an administration provide insights into a politician’s thinking but don’t capture the nuances that will likely emerge as a result of the give and take of the legislative process, not to mention the realities of the broader economic cycle that is ticking in the background. As we have noted previously, the economic cycle has helped shape the economic and market outcomes of administrations since the 1960s.
This view was echoed by Federal Reserve Chairman Jerome Powell in his press conference following the latest Federal Open Market Committee meeting, at which the Fed voted to cut rates by 25 basis points. “Clearly, the legislative process takes a lot of time. And, of course, the real question is not the effect of that law, it’s all of the policy changes that are happening: What’s the net effect and, you know, the overall effect on the economy at any given time?” Powell said.
While Powell avoided answering questions about the impact the new administration may have on the economy, he noted that members of the Fed view current risks to each side of its dual mandate of maximum employment and price stability to be even. The significance of this view is that it likely gives the Fed more latitude in the pace and size of cuts going forward. Simply put, with parts of the economy showing remarkable resilience and the labor market loosening but still appearing to be strong, the Fed is under less pressure to act on rates. Indeed, following Powell’s comments, market expectations of the number of rate cuts going forward fell, with the consensus being that the Fed would likely cut again in December by 25 basis point and then pause at its first meeting of 2025. For context, shortly after the first rate cut in September, the market was pricing in expectations the Fed funds rate would be at 3 percent in June 2025. This level was widely viewed at the time as a level where rates would neither stimulate nor slow economic growth. Since then, market views have dramatically shifted, and investors are now pricing in expectations that rates will be at 4 percent in June and won’t even dip below 3.75 percent until well into 2026.
Though the chances of a continued soft landing into 2025 appear to be improving, steady economic growth is not guaranteed. The U.S. economy has become highly bifurcated as elevated interest rates have had widely varying impacts on different segments and industries. Low- and middle-income consumers are facing high prices at a time when their savings are depleted, and they continue to struggle as floating-rate debt (such as credit cards and auto loans) remains elevated. Contrast that with higher-income consumers, who often have fixed-rate mortgages with houses that have appreciated in value even as rates have increased. These individuals often have savings accounts that have benefited from increased rates, while equity markets have also pushed to all-time highs. Similarly, large companies are getting larger, while smaller companies that rely on floating-rate debt are struggling. Manufacturing has been in a slow environment for much of the recent past, while the services side has remained relatively robust.
Ironically, despite the Fed’s recent rate cuts that have brought short-term rates down, interest rates on intermediate- and longer-term debt have risen, with the two-year Treasury rising 0.71 percent from its recent post-rate-cut low, while the 10-year has now risen by 0.68 percent. Evidence of how these moves affect consumers is reflected in how mortgage rates reacted. The Bankrate 30-year fixed national average mortgage rate has risen from 6.58 percent in mid-September to 7.23 percent at the end of last week. Put simply, rates have moved higher and continue to put pressure on rate-sensitive parts of the economy.
Core inflation has proven stubborn, yet consumer optimism may lead to greater demand for goods and services, which could slow the disinflationary process for the services side of the economy. Similarly, while the trend in jobs growth has been weak over the past several months, the pace of wage growth has declined at a slower pace and is still above a level consistent with the Fed’s goal of sustainable inflation readings of 2 percent. Should demand for workers in the services side of the economy continue to hold firm, it may take an extended period before wages no longer pose a threat to reaccelerating inflation or results in margin compressions for businesses. Likewise, as last week’s University of Michigan Sentiment survey showed a jump in consumer optimism, some of the improved outlook is likely tied to expectations of additional rate cuts by the Fed. If those fail to materialize, it could lead to disappointed consumers reining in their spending.
Given the above-mentioned risks, as well as the uncertainty that is a natural byproduct of a new incoming administration in Washington, we believe investors would be well served by not rushing to conclusions. Investors, in our view, should follow an investment plan for which an unexpected twist or turn doesn’t have an outsized impact on the long-term success of achieving their financial goals.
About the Author:
Brent Schutte, CFA, is chief investment officer of the Northwestern Mutual Wealth Management Company.
