“Trump bump”: Why markets have rose-coloured glasses on, for now

In the end, the result was largely in line with what forecasters had expected, with former President Donald Trump carrying the swing states necessary for a solid electoral college victory despite a narrower win in the popular vote. If there was one mild surprise, it was the “red wave” in Congress, which will make it easier for Trump to enact his policy agenda.

Prior to the election, we’d expected a Trump win and believed it would be bullish for markets, and that’s exactly what transpired: U.S. markets reacted positively—and were probably equally as happy that there was no contested result. Three days after the vote, and a day after another interest rate cut from the U.S. Federal Reserve (Fed), the S&P 500 briefly topped the psychologically significant 6,000 mark for the first time ever.

Why were markets so jubilant? In short: tax cuts. Given the likelihood of pro-business polices under a Trump White House and GOP-controlled congress, we are bullish on U.S. markets and expect a strong rally to end the year. The biggest winners are likely to be U.S. Equities broadly, as well as small-cap stocks and Financials. Conversely, China, Healthcare, and some green-related segments could have a tougher time, and the U.S. dollar (USD) is likely to decline as a result of Trump’s stated goal of making U.S.-manufactured goods more competitive. Overall, spending can be expected to continue, tax cuts are likely to proceed, and confidence in U.S. markets to remain high.

Given the likelihood of pro-business polices under a Trump White House and GOP-controlled Congress, we are bullish on U.S. markets and expect a strong rally to end the year.

A parting note of caution, however. On the campaign trail, Trump frequently touted the ways his approach to trade and foreign policy would differ from President Joe Biden, especially with respect to new tariffs and ongoing conflicts in Ukraine and the Middle East. If Trump follows through on his promises—and there is no reason to think he won’t—then there may be some measure of geopolitical and trade-related risk that are not currently being priced into markets. While the details of the Trump administration’s policies won’t be known until after he is inaugurated in January, we’ll be closely monitoring the situation to determine what ramifications they could have for markets over the next four years.

U.S. outlook

A reoccurring theme, in our view, is that U.S. expectations are too low and the bar to clear an easy one. Third quarter Gross Domestic Product (GDP) came in at 2.7%, a full percentage point above economists’ expectations a month earlier. The consensus view until the summer was for growth to closer to 1%—a drastic shift from below cruising altitude (trend at 2%) to above cruising altitude, underscoring a remarkably enduring resilience we continue to see in the U.S. economy. For Q4, we’re looking at growth that is likely to again top 2% annualized, and now on top of that, we have an election outcome likely to fuel “animal spirits,”¹ especially among small business owners (who we know are predominantly Republican). Recall in the first Trump administration, business creation in the first year went through the roof. If that replicates itself again, it should deliver an even more optimistic outlook for the economy. In short, the U.S. exceptionalism of recent years should continue compared to other economies—a fact that may be reinforced through the threat of tariffs, which could be punitive on other economies.

Canada outlook

In Canada, we continue to see more of the same tepid backdrop. Year-on-year GDP will struggle to run above 1-1.5% over the next couple of quarters. The good news is, we’re not talking about full-blown recession. Domestic job creation remains sluggish, and much slower than population growth which is concerning. The overall employment rate is declining—something typically associated with recession. There is no question regarding whether the Bank of Canada (BoC) should be reducing policy rates—we know the mortgage “storm” is going to be meaningful in 2025 (with over one million households scheduled to renew). Rates are still on the restrictive side but we expect some time in the first half of 2025 for rates to turn stimulative, easing pressure on borrowers. We also expect to see support from the U.S. economy—always a positive for the Canadian market. That will be a key ingredient to see growth prospects improve through the second half of next year. Our current view on the impact of U.S. tariffs on Canada is that the risk is manageable. But that could change.

International outlook

Internationally, it was already a challenging backdrop before the tariff threat solidified with a Trump electoral win. The German economy is not doing well, fueling its own political tensions—we may see voters there shifting away from centrist governments, as well, perhaps materially shifting the policy agenda in a Europe that is about to face forceful trade headwinds. The Euro is going to be one of the areas where we’ll see direct evidence of tariff pressures, with a weakening expected from the so-called Trump trade (joining the Yen). The irony of an “America first” policy agenda is that it means a stronger USD near term—which is a key reason why we discount some of the more extreme trade-war scenarios: they would mean even more USD strength. We are likely to see many smaller deals, like what we saw rolled up in the USMCA (U.S.-Mexico-Canada Agreement). To be sure, there is no question Mexico is a target, however. After China, Mexico is the number two target of U.S. tariffs, because of how much production is there. Canada will need to minimize the collateral damage.

Are we suddenly in a bull market for stocks, and bearish one for bonds? Absolutely. With Trump in power, we have the promise of corporate tax cuts and fiscal stimulus kicking the economy into a higher gear of growth, benefitting stocks and crimping Fixed Income. We’ve seen a spike in yields that has eased off a bit given the Fed cut policy rates two days after the election—which was no surprise—but markets are already pricing in a slightly higher terminal rate based on the election outcome. While we by no means felt we had as crystal ball on the election, we had our biases which were ultimately proven correct, albeit to an even greater degree than expected. Our portfolios were well positioned for the final result: overweight Equities, favouring the U.S., with sector tilts that included U.S. Banks and Industrials, with a relatively neutral Duration exposure.

With respect to stocks, we've seen a resurgence in the Trump trade—and speaking of animal spirits, small caps are probably the best example. We’d seen glimmers of hope in that sub-sector this year, but nothing really stuck in the absence of a catalyst. We now have that catalyst: a pro-growth administration that's very business-friendly—very U.S. business-friendly in particular. For global Equities confronting trade war risks, Mr. Trump likes to start strong and then back off. Here in Canada, we are the lesser of many evils when it comes to international trade concerns. China and Mexico are probably the Trump administration’s largest concerns.

On bonds, we expect we’ll see elevated yields in the immediate term, though we will probably get a pullback once the market looks at the other side of the coin. We tend to talk about tariffs as being inflationary and pushing up interest rates. It also means a strong USD, which will be a natural offset that will reduce the cost of imports from China and Europe. The longer-term concern is, what does potentially higher inflation, a Fed that can't cut rates quite as aggressively as we thought, and elevated fiscal spending do to the U.S. deficit?

The election has triggered an across-the-board reevaluation in our monthly scores, tilting our biases toward the U.S. market even more (from 1 to 2) and to a lesser extent, Canada (from -1 to 0 or neutral) while our ratings on EAFE (Europe, Australasia, Far East) and Emerging Markets move to -1 or slightly bearish. From a top-down macro perspective, we have a U.S. economy growing at 3% with inflation at 2.5%—a Goldilocks scenario with growth outpacing inflation. Within that dynamic, the Fed is easing rates while a Trump-led policy environment opens the door to more fiscal stimulus in the form of tax cuts. From a bottom-up perspective, individual corporate earnings are surprising to the upside, beating estimates by about 7% on average, which is well above historical norms. One caution is that sentiment is elevated, yet here too we do not believe it is stretched, furthering our conviction on U.S. Equities.

With respect to Canada, the United States is, of course, the country’s largest trading partner. All else being equal, stronger U.S. growth should mean the same for Canadian growth. On the negative side, there is the threat of tariffs. However, we think those risks are manageable, given that Trump has bigger fish to fry—Canada is simply lower down the priority list compared to China, Mexico and Europe given the fact we have relatively balanced trade. In fact, Canada could be a net beneficiary of “near shoring.” We’re not outright bullish on Canada, but we have moved to neutral.

We’ve downgraded international (EAFE) and Emerging Markets (EM) given the spectre of tariffs. In Europe, we have growing political strain adding uncertainty there (i.e., in Germany). In EM, China is the biggest target for Trump from a tariff perspective, though they are probably not going to impose the extreme numbers the new administration is touting. It is still a material negative, and especially so when combined with the serial disappointments regarding Beijing’s domestic stimulus efforts.

A better-than-expected U.S. economy coupled with a pro-growth Trump administration should mean the Fed is going to slow the pace of interest rate cuts into 2025. That will not come as a great surprise, given the market has priced out many of those cuts already. Barring any significant developments, we don't see the U.S. terminal rate rising much further beyond 3.5%. The bond market has largely digested the Trump agenda and prospects for stronger growth. There still could be more surprises to the upside, but we think yields at these levels make sense and are close enough to fair value.

Canadian Duration² continues to look more attractive because of that wide gap in economic performance versus the U.S. To be sure, even though the Canadian economy has deteriorated on an employment and growth basis since the last BoC meeting, domestic rates are up. Yet the move has been in sympathy with the U.S.—and they're up a lot less. We still think longer dated Canadian bonds are going to be largely influenced by the U.S., but in terms of relative value, we prefer domestic Duration, given the gap in economic performance isn't going to close anytime soon.

We’ve moved both Investment Grade (IG) Credit and High Yield up a notch given the stronger underlying economy and pro-growth agenda. We do not see spreads widening that much, so we're happy to get that additional yield in IG. Similarly with High Yield credit, we were underweight because spreads were very tight but a Trump economic agenda means, in our view, those spreads shouldn’t materially widen out bringing our score to neutral. To be clear, we prefer Equity to High Yield—if we’re comparing government credit versus investment grade corporates, we'll now consider the latter. If we are talking High Yield bonds versus Equity, we’ll similarly take the latter. Lastly, on EM Debt, a stronger USD is a headwind despite the prospects for interest rate cuts.

Now that we have clarity over which way the U.S. economic policy is going, it favours small caps. That said, if interest rates climb too far, too fast, that could be thrown into reverse, so we’re watchful. But the offsets to that risk are expected fiscal spend, reduced corporate tax rates and an “America first” trade policy. For the next six to 12 months, small caps have some runway to outperform. The banking sector is a prime example—i.e., for regional banks versus large cap Financials, this is the time for small- to mid-size lender stocks to start playing catch up, and not just among the banks but throughout the entire index. Another factor to mention is the change in Yield down to neutral (0). A higher rate environment is less beneficial for yield-oriented stocks, similar to bonds.

On sectors, a strong U.S. consumer is about to get stronger in the face of tax cuts, benefitting multiple segments near term. Technology is looking pretty good still—The Magnificent Seven particularly. Consumer Discretionary should get a lift in our view, with Amazon and Tesla dominating that sector. The offset is a potential weakening in consumer staples valuations—a reflection that the market is not worried about playing defense, at least for the next three to six months. In the same vein, given the likelihood of higher interest rates and reducing defensive positioning, we expect Utilities to face near term pressure.

We have upgraded the Canadian dollar from a -1 to a neutral (0). It may seem counterintuitive given how much we’ve discussed USD strength but the CAD has been pretty beaten up over the past several months. We are nearing its lower limit of fair value. The other consideration is what the BoC can—or can’t—do if the Fed is slowing down its easing cycle. The argument is there that the BoC needs to cut rates, but policymakers now must be cognizant that cutting too far ahead of what the Fed does is going to damage the currency, which itself is inflationary.

We’ve downgraded Gold to neutral (0). We’re of the view that it is time to lock in recent gains. We still think bullion long term has value, as a hedge against perhaps more violent trade wars to come or more aggressive de-dollarization. But as bonds are selling off because of higher real rates, that’s not great for Gold in the near term, either.

Lastly, we had many options positions on heading into the U.S. election in terms of downside protection. We are, quite frankly, happy to see that those hedges are not worth very much because the market has gone up—and that's exactly the intent of our options use from a hedging perspective. We never complain about having an umbrella out on the golf course on a sunny day—it’s there when you need it. We were able to stay overweight Equities with some asymmetrical downside protection.