How Investors Should React to the Election
The U.S. presidential election is over. With 50.3% of the popular vote going to President-elect Trump and 48.1% cast for Vice President Harris, the fact remains that the country is roughly split along party lines. That means many readers likely feel excited about the result of the election, while many feel disappointed.
Investors should feel neither.
I know it’s challenging to remain emotionally neutral in the current environment. In the days following the election, there was a frenzy of market action with small-cap stocks, energy companies, and banks rallying in a big way. The S&P 500 Index posted its best post-election day performance in history.(1)
However, the emotional weight of the moment can lead to bad decisions in either direction. An investor could have avoided stocks during President Trump’s first term or the last four years under President Biden, and for the same reason—because they strongly disliked the leader and his policies.
But that would have been a mistake.
Stocks have risen substantially over the past eight years and traded near all-time highs in the days leading up to the 2024 election. Thinking even more specifically, President Biden has been one of the least friendly presidents to the fossil fuel industry from a policy perspective, but the U.S. produced a historic amount of oil in 2023, and the Energy sector has been a strong performer during his tenure. President-elect Trump was a China hawk when he was in office, but Chinese stocks went up a lot while he was president.
And yet, in the days since the election, there has been a torrent of headlines and stories about capitalizing on the ‘Trump trade,’ or positioning in sectors or industries that stand to benefit from a new set of policies. In the small-cap realm, the Russell 2000 Index posted its best single-day gain in almost two years, on the theory that a looser regulatory regime coupled with tariffs and other protectionist policies could bolster small companies that largely operate in domestic markets.
The Financials sector also saw an immediate boost following the election. Bank stocks from regionals to major money center banks experienced broad gains. Expectations for falling regulatory scrutiny and rising levels of dealmaking particularly boosted small and midsize regional banks, but it also lifted larger investment banks that could benefit from a flurry of new deals and M&A across the economy – but specifically in the technology sector.
These investment ideas are all logical in theory. But they are also built on assumptions about what future policy will look like and how those policies will impact the economy. In other words, they are being driven in the short run by changes to sentiment, not changes to economic fundamentals.
History reminds us to be cautious about trading on sentiment. In 2016, Energy was the best-performing sector and small-cap stocks were the top performing asset class, arguably for similar reasons in anticipation of the Trump presidency. But investors who re-positioned because of expectations of policy impact would have ultimately been disappointed in the results: small-cap stocks went on to underperform large-caps for the next three years, and Energy was the worst-performing sector in 2018, 2019, and 2020.
Bottom Line for Investors
In my view, the stock market’s rally in the days following the election was less about pricing-in exorbitant earnings and economic growth in the future, and more about the removal of uncertainty. As I’ve written many times before, stocks don’t like uncertainty, and the fact that the election result was clear and decisive removed this potential negative.
In the coming months, there will be ample time to assess what policy changes are being enacted and what their impact on the economy could be. But it’s too early for that now, and in my view, making investment decisions or positioning a portfolio based on what could happen is a sentiment trap.
At the end of the day, investors must remember that the U.S. and global economy are extremely complex, with many different forces and trends determining the direction of the business cycle. Politics is just one piece of it.
1 Wall Street Journal. November 6, 2024. https://www.wsj.com/finance/stocks/wall-street-salivates-over-a-new-trump-boom-c32cf952?mod=djemMoneyBeat_us
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