Why Markets Fooled Investors After Trump Won

The market did the exact opposite of what everyone thought.

The immediate reaction in financial markets to Donald Trump's surprising triumph in the U.S. presidential election has confounded many. The way stocks and bonds have moved in the days following Trump's election has been the exact opposite of what most people thought would happen.

The S&P 500 rallied 1.3% in the two days after the election, while the narrower Dow Jones industrial average jumped to a record high on Thursday.

S&P 500

Meanwhile, Treasury bond prices tumbled, pushing the benchmark 10-year yield to as high as 2.15%, its loftiest level since January (bond prices and yields generally move inversely).

US 10-Year Bond Yield

What was supposed to happen―according to the pundits―was a plunge in stocks and a rally in safe-haven Treasurys due to the increased uncertainty that a Trump presidency brings. But as is often the case when it comes to markets, the conventional wisdom turned out to be wrong.

Two Theories On Market Moves

With the benefit of hindsight, there are two theories that explain this week's market moves. The first is that stocks rose thanks to anticipation of lower taxes and regulations, and increased fiscal spending on things like infrastructure in a Trump administration. At the same time, Treasury bonds tumbled due to the prospect of increased borrowing, growth and inflation as a result of Trump's policies (and those Trump policies became a bigger reality, with Republicans now controlling the White House, Senate and House of Representatives).

It's difficult to pinpoint exactly why markets move the way they do in any short-term period, but these explanations sound reasonable enough.

The second theory is that markets aren't reacting to the election as much as the other factors that were driving them all year long. In the weeks leading up the election, the stock market was trading near all-time highs amid hopes of accelerating corporate earnings growth, while bonds were selling off on the prospect of another Fed rate hike in December.

In that context, this week's moves don't seem all that surprising.

Sectors Diverge

The first of the above theories is backed by sector moves within the stock market. In the two days following the election, financials, health care, industrials, and materials were the top-performing sectors.

That makes sense in the context of a Trump victory and GOP control of Congress. Financials benefit from less regulation and a steeper yield curve; health care benefits from less regulation; industrials and materials benefit from increased infrastructure spending.

On the other hand, utilities, consumer staples and real estate were the worst-performing sectors in the period. Utilities and real estate in particular are interest-rate sensitive, and likely sagged due to the spike in yields. It's less clear why consumer staples underperformed so significantly, but it could have to do with the fact that safe havens in general (Treasurys, gold, staples) fell out of favor this week.

S&P 500 Sector Returns For Two Sessions After Election

Looking Ahead

Looking ahead, investors will keep a close eye on which of his promised policy proposals Trump implements. The market's reaction so far gives some sense of where things may be headed if the growth-positive aspects of Trump's economic plans come to fruition.

Conversely, if the president-elect implements tariffs or other trade barriers, as he has threatened, markets may move into a "risk-off" mode, weighing on stocks and supporting bonds.

Moreover, even in the bullish case, investors will be sensitive to how high interest rates go if they continue to move up. A gradual rise can be absorbed and may even be welcomed, while a surge to much higher levels could weigh significantly on economic growth and stock market valuations.

Contact Sumit Roy at [email protected]