The shockwaves from the surprising results of the US election continue to roil markets.
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If investors had been told before this month’s election that not only would Donald Trump win the US presidency, but also the popular vote and that the Republicans would gain control of both branches of Congress, they would likely have anticipated a strong positive reaction from US equity markets.
One might have argued for either a positive or negative reaction from markets outside of the US, with the bull case pointing to higher US growth benefiting the rest of the world, and the bear case highlighting the risk of tough tariffs being imposed.
For fixed income markets, the consensus would probably have called for higher market rates, reflecting faster growth, higher inflation, and fewer cuts in official interest rates by the US Federal Reserve.
The market reaction so far has been broadly in line with these expectations, but there have still been surprises. The initial positive reaction of US equities has been partly reversed over the last few days (see Exhibit 1).
A small pullback after the initial euphoria may have been foreseeable, but the negative returns of the past week have largely been concentrated in two sectors: technology and healthcare.
The decline in the latter segment reflects concerns over the proposed head of the Health and Human Services Department, Robert F. Kennedy, Jr.
The drop in tech stocks, though, is not because of any particular news; rather, it relates to the evolution of the fixed-income market.
Fixed income reaction – Relatively low key
While equities moved sharply on the outcome of the election, the reaction in bond markets was comparatively muted. The S&P500 index was up by more than 5% at the peak, but the yield on the 10-year Treasury note gained just under 15 basis points (bp).
The market’s forecast for the level of the official fed funds rate in one year rose by just 25bp. This is arguably small given the market concerns over the potential inflationary impact of higher tariffs, a sharp reduction in labour market supply due to restricted immigration and proposed mass deportations, and a significant increase in budget deficits and debt levels due to tax cuts.
Considerable doubt makes pricing tricky
The explanation may lie in the considerable doubt over how these issues will actually evolve. While Trump (like most politicians) said many things during the campaign, what he ultimately implements remains unclear. Moreover, policies do not solely depend on him; Congress will have at least some say. As a result, fixed-income markets may be finding themselves unable to price in a major change in the outlook as the future is simply too uncertain.
Bond yields have nonetheless changed, and that may explain the recent decline in tech stocks after the initial surge. Immediately after the election, both bond yields and equity markets rose in anticipation of faster growth (see Exhibit 2).
While the expectation of faster growth is positive for tech stocks, the sector is particularly sensitive to moves in interest rates: given that a greater share of its earnings lies further into the future than for other sectors, a change in the discount rate has a bigger effect on the current net value of that earnings stream.
The initial increase in US Treasury yields might have been expected to lead to a decline in the tech-heavy NASDAQ index, but as yields fell quickly, the growth factor won out.
Subsequently, US Treasury yields have moved up again and the NASDAQ has pulled back. Once yields settle, however, the outlook for rising earnings should predominate and we anticipate continued gains for the tech index. A surge in yields, however, would likely lead to another sell-off.
Europe and China indices hit
The third forecast – that non-US equity markets could suffer on the news of a Republican sweep – has been partly borne out. Market concerns over higher tariffs are focused particularly on China and Europe, and not surprisingly these stock markets have lagged.
The S&P500 index is still up by 3.2% from 4-18 November, the NASDAQ 100 by 2.9%, and the small-cap Russell 2000 by 4.0%, while the MSCI Europe index is down by 1.4% and the MSCI China by 2.4%.
The tariff worries are piling in on top of previously existing doubts over the outlook for growth in both regions. The evolution of any negotiations over trade and tariffs will likely be critical to the performance of these markets in 2025.
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