Market Commentary: October 2024

Written as of November 13, 2024.

Highlights this Month

• Limited speculative activity in the S&P 500 suggests reasonable market valuations despite overall index strength.
• The categorization of certain stocks by Republican or Democratic policies grows more complex as political alignments evolve.
• Investor optimism for the next 12 months seems high, with most remaining bullish and expecting a soft landing for the U.S. economy.
• Bond yields rise due to stronger economic performance, with Trump’s victory also influencing market expectations.
• Post-election, sectors like financials, energy, and industrials performed well, signalling confidence in Trump’s economic policies. 
• Potential risks to Canada's economy and interest rates. 

October in Review

October marked the end of a five-month cross-asset rally, as U.S. equities, long-term Treasury bonds, investment-grade credit, and high-yield bonds all posted losses. This decline extended globally, sparing only Canadian large-cap stocks.

Figure 1

Increased volatility contributed to weaker returns, but credit markets remained stable throughout.

Bloomberg highlighted increased volatility in both equities and fixed income, contributing to weaker returns (Figure 1). However, credit spreads remained stable, suggesting that credit markets anticipated minimal disruption. The decline in investment-grade and high-yield bonds was likely driven more by rising Treasury yields than by concerns over credit quality.

Higher volatility is typically associated with market stress, but current credit market behaviour suggests a more stable outlook. As discussed below, we will give credit markets the benefit of the doubt for now. The rise in rates appears to be fueled by stronger economic growth, and pre-election positioning likely drove the increase in equity volatility.

Despite market uncertainty, the S&P 500 surprised analysts by maintaining strength above many year-end targets.

Although U.S. stocks declined in October, most of the damage was done in the last two trading days of the month. Despite the uncertainty surrounding the pivotal U.S. presidential election, the S&P 500 continued to trade higher than many year-end targets set by analysts, surprising Wall Street (Figure 2).

Figure 2

Limited speculative activity in the S&P 500 suggests reasonable market valuations despite overall index strength.

According to Bloomberg, only 68 S&P 500 stocks traded above consensus price targets, with just 17 exceeding their targets by more than 5% (Figure 3). This limited speculative activity indicates that while headline indices have shown strength, much of the market is still grounded in reasonable valuations.

Figure 3

Many investors adjusted their portfolios based on the expected outcomes of the presidential election.

Many Wall Street firms, including Goldman Sachs, developed baskets of stocks aligned with either Republican or Democratic policy forecasts. The Democratic-leaning stock basket gained momentum after Vice President Harris' debate victory in September but fell as Trump made gains in the polls (Figure 4). Certain stocks, such as Trump Media & Technology, represent clear Republican policy plays and could see significant valuation changes under a Trump administration. 

Figure 4

The categorization of certain stocks by Republican or Democratic policies grows more complex as political alignments evolve.

Other stocks are trickier to categorize and place in either the Republican or Democratic basket. For example, Société Generale put Tesla in their Democratic basket due to the association of electric vehicles with renewable energy and subsidies (Figure 5). However, this view may be simplistic. Given Trump’s newfound appreciation for Tesla and its CEO, Elon Musk, the political alignment and perception of the company may shift under his administration.

Figure 5

Market action wasn’t all about the election last month.

Cyclical stocks continued to lead the market higher (Figures 6 and 7). The relative strength of these stocks compared to defensive sectors has been tracking closely with Trump’s election odds, but the Citi Economic Surprise Index aligns with cyclical performance even more. This raises the question: Are strong economic data or Trump’s policies driving stocks higher? In Bloomberg’s MLIV Pulse survey (October 14-18), 45% of respondents cited corporate earnings as the top issue for stocks, while 39% pointed to the U.S. election and only 16% prioritized Federal Reserve rate cuts. The survey also found that 74% of respondents expected earnings to be strong, supporting the rally.

Figures 6, 7

Investor optimism for the next 12 months seems high, with most remaining bullish and expecting a soft landing for the U.S. economy.

Optimism was echoed in Barron’s Big Money Poll, where 50% of institutional investors were bullish about the coming year, compared to just 18% who were bearish. Additionally, 59% predicted a soft landing for the U.S. economy, while only 16% foresaw a recession within the next year.

Despite high investor optimism, bond markets signal a different story with rising yields and growing debt concerns. 

A Bank of America survey in October supported this sentiment, showing that only 19% viewed a U.S. recession as the biggest market risk, while 33% cited geopolitical conflict as their top concern (Figure 8). Whether driven by Trump’s win or strong economic data, the message suggests current conditions are favourable for stocks.

Figure 8

Bonds tell a different story.

Data by Raymond James shows that the U.S. 10-year Treasury yield has been moving with the dominant equity market narrative for the past couple of years (Figure 9), but it’s not clear what is causing the current back up in yields. Previously, yields fell as the economy slowed but remained stable. The current increase is puzzling.

Figure 9

According to Bloomberg, the 10-year yield was climbing along with the Citi Economic Surprise Index and Trump’s re-election odds (Figures 10 and 11).

Figures 10, 11 

Bond yields have been climbing, driven by the expectation of higher deficits under Trump’s presidency. According to the Committee for a Responsible Federal Budget, the impact of Trump’s proposed policies could add nearly $8 trillion to the national debt (Figure 12). That’s a significant amount of bonds the U.S. Treasury Department will need to account for.

Figure 12 

The rise in inflation expectations is linked to Trump’s policies, with potential effects on bond markets and the economy.

It could get even more challenging for the bond market. Not only is a Trump agenda assumed to result in higher deficits, it’s also likely to lead to higher inflation. According to a poll conducted in early October by the Wall Street Journal, 68% of economists believed inflation would be higher under Trump. Mass deportation and higher tariffs are among the two big drivers that could contribute to higher inflation.

 According to the Congressional Budget Office, the impact of deporting 8.3 million people would result in CPI peaking at 5.6% in 2026 (Figure 13). As for tariffs, 10% across the board would increase CPI to 3.7% next year, while 60% tariffs on Chinese imports would see CPI peak at 4.4% (Figure 14).

Figures 13, 14

Bond yields rise due to stronger economic performance, with Trump’s victory also influencing market expectations.

Russell Investments suggests that about half of the increase in 10-year yields is linked to the U.S. election, with the other half attributed to a resilient economy (Figure 15).

According to Bloomberg, nominal U.S. GDP growth over the past four years has been the strongest since 1987, with 10-year Treasury yields closely tracking this growth (Figure 16). Since the 10-year yield bottomed in mid-September, Strategas believes that growth, rather than inflation, has been the primary driver of rising yields. Notably, 52 basis points of the 76-basis point increase in yields were driven by higher real rates, which typically signal economic growth, while only 25 basis points came from rising inflation expectations (Figure 17).

Figures 16, 17

Bond market closely balancing Trump’s re-election and stronger economic growth. 

So, did bond yields rise because markets were factoring in a Trump victory, or because of stronger economic growth? Likely both, though the election likely had an impact. Ahead of the November 5 election, betting markets placed the odds of a Trump sweep — where Trump wins the presidency and Republicans take both the House and Senate — at 38%. Société Générale estimated that such a scenario could increase 10-year yields by 39 basis points. In contrast, they expected yields to fall under other potential outcomes (Trump split, Harris sweep, or Harris split). Notably, higher bond yields were also part of Strategas’ “Trump 2.0 Investment Playbook,” which predicted that while the U.S. dollar would benefit from a Trump victory, bond yields would be a losing trade (Figures 18 and 19). This proved to be an accurate prediction.

Figures 18, 19 

Trump’s victory caused market reactions across several U.S. equities. 

U.S. equities largely reacted as predicted. The S&P 500 was up 2.5%, the Dow Jones Industrial Average increased 3.5%, and the small-cap Russell 2000 soared 5.8%. Like the Russell 2000, value stocks outperformed the day after Trump’s victory. While it is generally believed that Trump will be good for growth, when growth is plentiful (and expensive), as it is now, investors look for cheaper stocks. In other words, a rising tide lifts all boats, and value stocks may have more room to rise.

As highlighted by Goldman Sachs, smaller companies found in the Russell 2000 have a greater positive earnings sensitivity to a decline in the statutory tax rate (Figure 20). Small-cap stocks also tend to have more debt and would be negatively impacted by higher bond yields, but perhaps that’s a worry for another day.

Figure 20

Post-election, sectors like financials, energy, and industrials performed well, signalling confidence in Trump’s economic policies. 

Post-election, sectors like financials, energy, and industrials performed well. Meanwhile, currency markets showed weakness, especially for the Japanese yen, Euro, Canadian dollar, and Mexican Peso. Notably, sectors such as renewable energy and Chinese ADRs underperformed more than expected, while the Russell 2000’s rally indicated further potential upside for small-cap stocks (Figure 21). This response signals confidence in Trump’s economic policies, particularly those related to tax cuts and deregulation, although some uncertainty remains regarding higher bond yields' potential impact on small-cap stocks.

Figure 21 

The wealthiest individuals saw gains post-election, with Elon Musk leading the charge.

Despite a lacklustre performance from the NASDAQ 100, the wealthiest individuals saw healthy gains after Trump’s victory. According to Bloomberg’s Billionaire Index, the top ten wealthiest saw healthy increases, with Elon Musk leading the list (Figure 23). Much of his gain was attributed to Tesla, which rose over 15%, outperforming other major stocks like NVIDIA, Amazon, and Alphabet.

Figure 23

Trump’s policies may benefit certain companies, such as those linked to autonomous vehicles and tariffs.

Musk, a known Trump supporter, could potentially benefit from several potential policies. Some speculate that Trump’s proposed 60% tariff on Chinese imports could benefit Tesla’s EV sales. However, this raises the question of why other EV manufacturers, such as Rivian and Lucid, experienced declines following Trump’s election win. Musk’s gains could likely be linked to regulatory changes, particularly around autonomous vehicles. Tesla has heavily invested in its Robotaxi initiative, and with Trump in office, the regulatory landscape for autonomous vehicles could shift in a way that benefits Tesla’s goals. 

During the first Trump administration, stocks generally performed well, with notable exceptions: a sharp decline at the start of the pandemic and a significant correction in the fourth quarter of 2018. Looking at sector performance, energy and financials performed better under Biden’s administration than Trump’s, yet gains in technology, consumer discretionary, and healthcare contributed to overall market returns.

Trump will face a different economic landscape than in 2017, characterized by relatively steady growth, lower unemployment, and higher interest rates. While inflation is trending lower, it remains above the Federal Reserve’s target range. Additionally, both Trump and Biden’s fiscal policies have significantly increased government debt.

Having gained experience during his first term and faced challenges after leaving office, his motivations for the next four years are unclear. Not needing to worry about re-election, Trump may not feel the same pressure to pander to certain interest groups for support.

Investors face dilemmas about the future under a second Trump term, with political uncertainty impacting investment decisions. 

A Bear Traps Report illustrates the dilemmas investors face when positioning their portfolios for the next four years (Figure 24). At the top of the decision tree, investors must decide between a “Bad” Trump and a “Good” Trump scenario, each potentially leading to very different outcomes. While the chart’s specific recommendations are of interest, it’s particularly valuable for highlighting the stark contrasts in outcomes between these two potential paths. Who Trump chooses for his administration could provide clues as to which path he will take, but investors should remain vigilant. Given the likelihood of a chaotic Trump White House, the path forward remains uncertain.

Figure 24 

One near-term challenge for stocks could be the rising bond yields.

Comparing the performance of the S&P 500 ETF (SPY) with the iShares 20+ Year Treasury Bond ETF, a significant gap has emerged, with stocks continuing to rise while bond prices fall as yields increase.

Historically, it’s taken a two-standard deviation move in 10-year U.S. Treasury yields over 30 days before stocks begin to react (Figure 25). This move, estimated at around 60 basis points, suggests that rising bond yields are approaching levels where stock traders should start to take notice.

Stocks have generally consolidated after real rates hit 3-month highs. With real 10-year yields nearing this key threshold, currently around 2%, investors may need to closely monitor how stocks react in the near term (Figure 26).

Figure 26 

The Federal Reserve's influence on rising bond yields amidst rate cuts. 

Trump is not the only factor affecting bond yields. Overlooked amid the election fallout is the Federal Reserve and its influence as it normalizes monetary policy. With the Fed cutting rates, bond yields would typically be expected to fall, not rise. TS Lombard data shows that U.S. 10-year yields have historically declined after the Fed begins raising rates if a recession follows. Without a recession, 10-year yields usually stay flat for a few months before rising (Figure 27). This time, however, 10-year rates climbed immediately after the Fed began cutting.

Figure 27

Strategas attributes the recent rise in yields to similarities with the 1995 easing cycle, which they view as a mid-cycle adjustment comparable to today’s environment (Figure 28). In 1995, then-Fed Chair Alan Greenspan managed to cool the economy without triggering a recession. A recent Bloomberg chart highlights that both 2-year and 10-year bond yields increased after the first cut, similar to the current cycle.

Figure 28

Federal Reserve continues rate cuts as expectations shift.

As expected, the Federal Reserve followed its September 50 basis point rate cut with a 25-basis point reduction to the Fed Funds rate on November 7. Since the larger cut in September, market expectations for future cuts over the next year have fallen by a full percentage point.

While President Trump remains a key influence on future Fed policy, a stronger-than-expected economy is largely responsible for much of the recent shift. However, as Trump’s policies potentially take shape, the Fed will need to factor in their impact on inflation, adding uncertainty to an already volatile environment. 

Trump's "America First" agenda and its potential impact on Canada.

 Trump’s victory will also affect Canada, particularly regarding his "America First" agenda. Canadian exports to the U.S. significantly outpace those to the rest of the world, with energy, vehicles, and industrial equipment among the top exports (Figure 29). A weak Canadian dollar, currently near two-year lows, helps make Canadian exports more competitive.

Figure 29

Potential risks to Canada's economy and interest rates. 

While Trump is unlikely to directly target Canada, there may be increased pressure to boost defense spending and some adjustments to the USMCA agreement when it is up for renewal in 2026. For Canada, a key consideration will be how much room the Bank of Canada (BOC) has to continue lowering rates, especially given the recent decline of the Canadian dollar. Traders estimate that the neutral rate (neither stimulative nor restrictive) falls between 2.25% and 3.25%, leaving the BOC with approximately 100 basis points to go. Despite falling inflation, real rates have increased, and recent data from Bloomberg suggests that monetary conditions in Canada have become more restrictive (Figure 30).

Figure 30 

The widening interest rate spread and the Canadian dollar’s outlook. 

As the Federal Reserve follows a slower rate-cutting path than the BOC, the interest rate spread between the U.S. Fed Funds rate and the BOC rate has continued to widen. Scotiabank believes the Canadian dollar could remain within its two-year range between 72.18 and 73.41, with more downside risk than upside potential (Figure 31). The bank also warns of the possibility of a re-test of the Canadian dollar’s two-decade low. Canada’s economy remains vulnerable to the impact of higher interest rates on over-indebted consumers and inflated housing prices (Figure 32).

Figures 31, 32

Canada's lack of productivity growth poses long-term challenges.

A longer-term challenge for Canada is its lack of productivity growth. While Canada has experienced strong overall GDP growth, this has largely been driven by high population growth rather than improvements in productivity (Figure 33).

Figure 33

As a result, Canada’s GDP per capita has been struggling, especially when compared to the U.S. (Figure 34). Rosenberg Research points to the near-record gap in capital investment between Canada and the U.S. as a key factor contributing to this productivity shortfall (Figure 35).

Figures 34, 35

Immigration and labour issues could slow Canada's growth. 

New immigration and foreign work visa policies could put more pressure on Canada’s economic growth, with Rosenberg Research suggesting that Canada’s population may even shrink next year (Figure 36).

Figure 36

Housing shortage exacerbates Canada’s economic issues.  

Canada’s housing market exemplifies some of the country’s structural issues. Due to rapid population growth, there is a housing shortage. The government aims to build 3.9 million homes by 2031, an ambitious target considering current construction levels of around 350,000 per year.

Nearly 8% of Canadian workers are employed in construction, but with 20% aged 55 or older, there is a looming labour shortage. BuildForce Canada estimates that 134,000 residential construction workers will retire by 2033, while only 117,000 are expected to be hired. Targeting immigrant workers could help alleviate some of the strain, but construction is one of the least productive sectors, contributing to Canada’s lagging GDP per capita growth.

The challenge lies in balancing immigration needs with investments in productive industries, as a growing construction workforce alone will not solve Canada’s housing issues or improve long-term productivity. 

Canada's housing crisis and political risks.

Canada’s housing crisis may cost Prime Minister Trudeau his job, either through internal party challenges or a loss in the next general election to the Conservatives. This follows a broader global trend, as the Financial Times notes that every governing party in a developed country facing elections this year has seen a decline in vote share for the first time.

Potential market trends amid political uncertainty. 

On the positive side, despite political upheaval, S&P 500 trends show that investors have typically been rewarded over the long term, regardless of the president in office.

Markets often move sideways for a few months following an inauguration, especially when the incumbent party loses. However, historically, the November-to-April period is the strongest of the year, which could help offset the post-election market hangover.

Looking longer-term, the implications of a Trump presidency on markets remain uncertain. Early indications suggest that Trump's policies may be favourable for stocks, but less so for bonds. Lower taxes and reduced regulation could boost corporate earnings, but tighter immigration controls, potential mass deportations, and tariffs could stoke inflation, while higher deficits might prompt bond market sell-offs and push yields even higher.

This is all happening within the context of a relatively strong economy. The Fed’s easing cycle and its efforts to bring rates back to neutral levels may temper the impact of a Trump presidency, but resurgent inflation risks could make the central bank more cautious in its approach.