SCM's Deep Dive: What the Trump Trade Means for Long-Term Investors

While the political world will focus on the election for some time, financial markets have already shifted their attention to the next administration’s policies, Federal Reserve rate cuts, and the underlying economy.

In the remainder of the week following election day, the S&P 500 gained 3.7%, the Dow 4.2%, and the Russell 2000 index of small-cap stocks surged 6.1%. Bitcoin also surged above $90,000 for the first time. Even though this sudden market jump is positive for portfolios, staying disciplined by maintaining a long-term perspective and focusing on fundamentals is always important.

Valuations are above historical averages

Putting politics aside, chances are that the next administration will inherit strong economic tailwinds. While it’s clear that voters struggled with inflation over the past few years, rising prices initially from supply chain disruptions during the pandemic and, more importantly, overdone and significant government stimulus.

These shocks to the system have faded as inflation has fallen back toward 2%, prompting the Fed to cut rates, which supports the economy.

At the same time, the bull market rally since late 2022 means valuations across an array of asset classes are well above average. The post-election rally in recent days has only pushed valuations higher. For instance, the price-to-earnings of the S&P 500 is nearing post-pandemic highs and is only a few points away from its historic dot-com bubble peak.

History shows that markets can move back and forth between extremes as investors overreact to positive and negative events. This occurred after the 2016 election as well. Markets rallied throughout 2017 before facing a market correction in early 2018, which ended the year negative for the first time in a decade.

Markets then experienced a strong rally in 2019 until the pandemic derailed it in early 2020. While the past is no guarantee of the future, this shows that the market never moves up in a straight line, despite how positive the situation may seem at the time.

In uncertain situations, a north star that can guide investors is valuations. In the long run, there is nothing more correlated with returns than whether the market is cheap or expensive compared to measures such as corporate earnings.

While valuations are not market-timing tools—stocks can run well above fundamentals in the short run—they do tell us how to set expectations that reflect long-term trends.

Higher valuations correspond to lower expected returns.

Today, market enthusiasm is the result of the “Trump trade,” which refers to investments that benefit from the expected policies of the next administration.

This includes lower individual and corporate taxes, tariffs, light regulation, and deficit spending in areas such as infrastructure.

For a time after the 2016 election, this propelled markets due to optimism in financial markets, the strengthening of the U.S. dollar, and higher bond yields as investors anticipated pro-growth economic policies.

As the famous investor Benjamin Graham observed, "in the short run, the market is a voting machine but in the long run, it is a weighing machine." This is relevant today because many of the investments with stretched valuations, including tech stocks and cryptocurrencies, are especially prone to booms and busts.

When things go well, it seems foolish in hindsight to focus on valuations and earnings. However, the reason to do so is exactly because it is difficult to predict the exact winners.

As the accompanying chart shows, elevated valuations have often corresponded to lower or even negative longer-run returns. This occurs if those valuations take place later in the business cycle just before a correction. The hope is that this time is different, and the economy continues to grow steadily. But even in that scenario, markets rallying ahead of fundamentals could mean that returns are “pulled forward.”

Many asset classes beyond U.S. stocks have performed well this year.

High valuations, however, don’t mean we should avoid the stock market. Instead, they suggest we carefully construct and adjust portfolios in a risk-aware manner, using diversification as a key tool.

The accompanying chart shows that while U.S. stocks have performed well this year, many other asset classes have generated positive returns, too.

International stocks, for instance, continue to have much more attractive valuations than U.S. stocks. And while bonds have not performed as well recently with rates rising again, they still provide income and diversification benefits, especially in periods of market volatility.

Perhaps most importantly, long-term fundamentals suggest that the trends are still moving in the right direction. Corporate earnings have shown steady growth in recent quarters and GDP figures have been surprisingly strong. The Federal Reserve also implemented its second rate cut of the cycle after the election, lowering the fed funds rate by 25 basis points to a target range of 4.5% to 4.75%.

In its official statement, the central bank acknowledged evolving labor market dynamics, noting that conditions have generally eased while unemployment, though higher, remains at historically low levels. It highlighted that while inflation has eased substantially and the economy remains strong overall, labor market conditions have moderated compared to pre-pandemic levels.

During the post-meeting press conference, Fed Chair Powell presented a balanced view of the economic landscape, emphasizing both progress and continued vigilance. Your portfolio should be viewed in the same manner, balancing progress and vigilance.

The bottom line? Slower-moving economic trends drive financial success for long-term investors, not short-term market movements over a few days or weeks. As 2016 to 2020 demonstrates, investors need to maintain portfolios that can take advantage of market rallies while protecting against periods of uncertainty.

If you want to discuss this further, we offer a complimentary 15-minute call to discuss your concerns and share how we can help.

Stordahl Capital Management, Inc is a Registered Investment Adviser. This commentary is solely for informational purposes and reflects the personal opinions, viewpoints, and analyses of Stordahl Capital Management, Inc. and should not be regarded as a description of advisory services or performance returns of any SCM Clients. The views reflected in the commentary are subject to change at any time without notice. Nothing in this piece constitutes investment advice, performance data or any recommendation that any particular security, portfolio of securities, transaction or investment strategy is suitable for any specific person. Any mention of a particular security and related performance data is not a recommendation to buy or sell that security. Advisory services are only offered to clients or prospective clients where Stordahl Capital Management and its representatives are properly licensed or exempt from licensure. No advice may be rendered by Stordahl Capital Management unless a client service agreement is in place. Stordahl Capital Management, Inc provides links for your convenience to websites produced by other providers or industry-related material. Accessing websites through links directs you away from our website. Stordahl Capital Management is not responsible for errors or omissions in the material on third-party websites and does not necessarily approve of or endorse the information provided. Users who gain access to third-party websites may be subject to the copyright and other restrictions on use imposed by those providers and assume responsibility and risk from the use of those websites. Please note that trading instructions through email, fax, or voicemail will not be taken. Your identity and timely retrieval of instructions cannot be guaranteed. Stordahl Capital Management, Inc. manages its clients’ accounts using a variety of investment techniques and strategies, which are not necessarily discussed in the commentary. Investments in securities involve the risk of loss. Past performance is no guarantee of future results.

Copyright (c) 2024 Clearnomics, Inc. All rights reserved. The information contained herein has been obtained from sources believed to be reliable, but is not necessarily complete and its accuracy cannot be guaranteed. No representation or warranty, express or implied, is made as to the fairness, accuracy, completeness, or correctness of the information and opinions contained herein. The views and the other information provided are subject to change without notice. All reports posted on or via www.clearnomics.com or any affiliated websites, applications, or services are issued without regard to the specific investment objectives, financial situation, or particular needs of any specific recipient and are not to be construed as a solicitation or an offer to buy or sell any securities or related financial instruments. Past performance is not necessarily a guide to future results. Company fundamentals and earnings may be mentioned occasionally, but should not be construed as a recommendation to buy, sell, or hold the company's stock. Predictions, forecasts, and estimates for any and all markets should not be construed as recommendations to buy, sell, or hold any security--including mutual funds, futures contracts, and exchange traded funds, or any similar instruments. The text, images, and other materials contained or displayed in this report are proprietary to Clearnomics, Inc. and constitute valuable intellectual property. All unauthorized reproduction or other use of material from Clearnomics, Inc. shall be deemed willful infringement(s) of this copyright and other proprietary and intellectual property rights, including but not limited to, rights of privacy. Clearnomics, Inc. expressly reserves all rights in connection with its intellectual property, including without limitation the right to block the transfer of its products and services and/or to track usage thereof, through electronic tracking technology, and all other lawful means, now known or hereafter devised. Clearnomics, Inc. reserves the right, without further notice, to pursue to the fullest extent allowed by the law any and all criminal and civil remedies for the violation of its rights.