How will the "Trump trade" unfold next? How long will it last?

As the Republican Party's advantage in Congress gradually becomes apparent, market expectations for the "Trump trade" are also heating up.

Recently, Goldman Sachs analyst David Kostin released a report stating that a key factor driving the stock market up in the short term is the reduction of political uncertainty, which typically leads to strong year-end returns in presidential election years. By the end of 2024, the S&P 500 index is expected to reach approximately 6015 points; investors will increase their stock holdings after the election.

Société Générale's Kabra Manish believes that "the Trump trade is at its peak," and that cyclical trades in the U.S. should last at least until inauguration day (January 20), while stocks that rely on Federal Reserve rate cuts, such as small-cap stocks, will need to be reassessed at that time.

S&P 500 Index Expected to Reach Approximately 6015 Points by Year-End

Historically, the S&P 500 index has an average return of 4% from the election day in November to the end of the year. Goldman Sachs believes that if this trend continues this year, the S&P 500 index will reach approximately 6015 points by the end of 2024, which corresponds to a forward price-to-earnings ratio of 22 times, representing an increase of about 0.7% from the current level.

Analysis indicates that with the resolution of election uncertainty, recent economic growth data's resilience and ongoing Federal Reserve rate cuts support a healthy outlook for the U.S. stock market in the short term. However, there are risks; a further significant rise in the 10-year Treasury yield will limit stock price gains.

In September, on the day the Federal Reserve cut rates by 50 basis points, U.S. Treasury yields hit a year-to-date low of 3.62%, and then rose by 80 basis points to the current 4.42%. Goldman Sachs stated that, all else being equal, a large-scale rebound in interest rates is usually accompanied by a decline in stock prices. However, the S&P 500 index has risen nearly 3% alongside rising bond yields, indicating that the stock market has absorbed this volatility, primarily driven by better economic data.

Goldman Sachs predicts that the Federal Reserve will cut rates by 25 basis points to 4.5%-4.75% at this week's meeting and will lower rates by another 25 basis points at the meeting on December 18. Goldman Sachs stated:

“This should further ease financial conditions, but it also raises concerns that the Federal Reserve is initiating another major wave of inflation, which will steepen the yield curve further.”

Currently, both the S&P 500 index level and valuation multiples are at historical highs. Goldman Sachs maintains its forecast for the S&P 500 index to reach a target of 6300 points over the next twelve months, representing an increase of about 9% from the current level. Goldman Sachs stated that robust earnings growth should drive the stock market to continue appreciating next year, with expected earnings per share growth of 11% in 2025 and 7% in 2026, although these estimates may change as the new government's policy agenda becomes clearer.

Analysis suggests that if Goldman Sachs is correct, there is still considerable upside potential in the market. Bloomberg's John Authers stated:

"Due to tax cuts and regulatory easing, Trump 2.0 is seen as beneficial for growth. When growth is ample, investors will look for cheap stocks. There is a belief that regulatory easing will allow them to unleash their potential, and their balance sheets can withstand the possibility of bond yields soaring again."

Investors Will Return to the Market

Recent data shows that investors have reduced their stock risk exposure ahead of the election. Although the stock positions held by investors are not low, data from Goldman Sachs Prime Services indicates that hedge funds have simultaneously reduced both net leverage and total leverage in the weeks leading up to the election.

Similarly, the rise in implied volatility in recent weeks is consistent with historical patterns before elections and likely reflects market hedging activities. Goldman Sachs believes that as political uncertainty decreases, investors may return to the market, and an increase in positions could help the S&P 500 appreciate after the presidential election.

Small-Cap Stocks and Financial Sector Will Perform Well, Renewable Energy Stocks May Underperform

Analysts believe that the election results will have a significant impact on short-term market internal rotations. Although there are still months until the presidential inauguration and any subsequent policy changes, recent market relationships suggest that as market expectations for a Trump victory rise from about 55% to full expectation, themes such as small-cap stocks and the financial sector will perform well, while renewable energy stocks may underperform.

Compared to companies oriented towards international markets, stocks primarily focused on domestic revenue and supply chains show a slight correlation with the predicted probability of a Trump victory in the market. During the 2018-2019 period, domestic-facing and defensive sectors typically outperformed cyclical sectors with higher international business exposure, while the worst-performing sector was semiconductors. However, this time, thanks to Nvidia's outstanding performance, the semiconductor industry is currently supporting the entire market with its remarkable earnings growth.

Goldman Sachs also noted that if Trump's proposal to reduce the statutory domestic corporate tax rate from 21% to 15% is implemented, expected EPS (earnings per share) could increase by about 4%.

M&A Activity and Cash Spending Will Increase Next Year

Goldman Sachs believes that the regulatory stance of the Federal Trade Commission (FTC) and the Department of Justice (DoJ) antitrust divisions may become more lenient under the new government, and CEO confidence will be a key variable influencing executives' inclination to engage in M&A activities. Ongoing economic expansion combined with improved CEO confidence indicates that M&A activity will increase next year.

Goldman Sachs recently released its forecast for cash spending by the S&P 500 in 2025, expecting cash spending to grow from 8% in 2024 to 11% in 2025. Additionally, the $4 trillion in spending in 2025 will be roughly evenly distributed between returning cash to shareholders (buybacks and dividends) and investing in growth (capital expenditures, R&D, and M&A).

The cash M&A model indicates that after a 15% decline this year, M&A activity will rebound by 20% in 2025. Goldman Sachs stated:

“A stable economy and growth in earnings per share, a relatively loose financial environment, and controllable stock market fluctuations should support merger and acquisition activities.”

Goldman Sachs also expects the volume of new stock issuances to rebound in 2025. The IPO issuance barometer (an indicator measuring the macro environment for IPOs) currently has an index of 137, reflecting a stable macro environment.

The Trump trade is in its heyday, with a "shelf life" lasting at least until January next year.

Recent performance in the U.S. market shows cryptocurrency exchanges up 31%, regional banks up 13%, oil capital expenditures up 9%, and localization of services up 6%... Societe Generale's Kabra Manish believes that “the Trump trade is in its heyday,” with most of the gains from the Trump trade reflected in stocks, as FICC had already priced in the likelihood of a Trump victory before the election.

Manish stated that U.S. cyclical trades should last at least until Inauguration Day (January 20), and fundamental trades like beneficiaries of U.S. capital inflow (SGIXUSRE) should continue to perform beyond Inauguration Day, while stocks that rely on Federal Reserve rate cuts, such as small-cap stocks, will need to be reassessed at that time.