Trump Term Two: Market Déjà Vu?
Financial markets are buzzing with anticipation as the US prepares for President-elect Donald Trump’s second term. But this isn't the first time markets have reacted in such fashion to a Trump presidency. In fact, much of what we're seeing is reminiscent of the market movements following his 2016 victory. In this piece, we aim to dissect market reactions and trends, analyze how Trump's policies may shape financial landscapes again, and offer investors insights and strategies to help prepare for his return to the White House.
Initial Market Reactions
In the immediate aftermath of Trump’s decisive victory over Vice President Harris, the S&P 500 gained 5.1% within five trading days. This was accompanied by an even more impressive 9.8% rise in small-cap stocks (Russell 2000) and a 7.8% surge by financials (SPDR Financial Sector Fund)1. The equity rally, reflecting investor optimism about potential deregulation and tax cuts during Trump's second term, stood in stark contrast to the flat performance of Treasury Bonds (Bloomberg US Treasury Bond Index: 0.0%) amid concerns about rising inflation and budget deficits that may temper longer-term bond yields.
This market reaction wasn’t unexpected; we saw a version of this play out in the aftermath of Trump’s 2016 election victory (Figure 1, below). Developed market equities rallied, US small caps and financials outperformed, and US Treasuries slumped. And while the 2016 election results were far more unexpected, investors seem to be following a similar playbook now, channeling funds into asset classes positioned for growth under Trump’s expected policies.
Figure 1: Financial Market Returns in the Wake of 2016 Election
The market performance underscores assumptions that the regulatory environment during Trump’s upcoming term will be more favorable to investors than it would have been under Harris. Furthermore, markets expect the temporary tax cuts enacted during Trump’s first administration to now become permanent. Although this could boost the budget deficit and send inflation higher, it would be positive for risky assets.
The Tariff Tango
From a macro-economic standpoint, several policies advocated by the President-elect could profoundly impact economic conditions and the business climate in the US and abroad. During Trump's first term, tariffs on foreign imports, such as aluminum and steel, were pivotal policy moves that led to a series of market reactions, including currency depreciations against the US dollar. Tariffs on foreign imports are again likely to be at the top of Trump’s policy agenda.
We examined the timing of tariff announcements made during Trump’s last term in office and the subsequent market reactions. Figures 2 and 3 show market returns one and three months after the US imposed tariffs in March 2018, as well as following retaliatory tariffs on US imports announced several months later:
Figure 2: US Announces Aluminum & Steel Import Tariffs
- Most major currencies depreciated significantly against the US dollar three months after the announcement of US tariffs on aluminum and steel imports, particularly in emerging markets.
- Most major equity markets experienced negative performance one month after the imposition of tariffs. However, three months after the announcement, most developed markets had rebounded with positive equity performance, while emerging markets continued to struggle.
Figure 3: Retaliatory Tariffs Announced on US Imports
- Most major equity markets saw a significant rally following the retaliatory tariffs on US imports implemented by some nations in June-July 2018.
Investors can take cues from Trump’s first term when trying to anticipate future market moves. By analyzing past trends, we find that, broadly speaking, US tariffs on imports can cause the US dollar to appreciate relative to other currencies, but also potentially expose equity markets to increased volatility, particularly in emerging markets. On the other hand, the implementation of retaliatory tariffs can reduce some market uncertainty, resulting in a relief rally across most regions.
The Final Analysis
As President-elect Trump prepares for his second term, investors face a familiar yet complex landscape. Understanding past market reactions to Trump's policies, tax cuts, and tariffs will be essential for making portfolio positioning decisions. We examined historical trends that can be useful in building a framework for navigating market volatility in two recent publications, the Q4 2024 Outlook and our whitepaper on election cycle volatility. In both pieces, we observe that increased uncertainty leading up to an election often spurs a rally afterward as investors collectively exhale. When markets are unpredictable, strategies such as portable alpha overlays (for institutions) and buffered ETFs can help manage downside protection while maintaining market exposure to potential gains. With the election results in, investors can use insights from Trump's first term to anticipate the impact of potential future policy changes.
1Returns calculated from November 5th (Election Day) to November 11th 2024.
For compliance use only PGIM Quant- 20241119-2930
