Stocks are set to rally further - but the bond market doesn't like what it sees
If history is any guide, U.S. stock prices will experience extremely strong returns if the Republicans sweep the White House, Senate and House
Here is the good news for U.S. stock investors. Jurrien Timmer at Fidelity Investments studied the two- and four year post-election returns of the S&P 500 SPX. If history is any guide, U.S. stock prices will experience extremely strong returns if the Republicans sweep the White House, Senate, and House. While the final tally for the House is incomplete and won't be known for some time, Republicans appear to be on their way to a sweep, according to the Cook Political Report.
Tactically, the post-election melt-up can be explained by the unwind of trading hedges. It's difficult to tell how far it will run, but the market isn't overbought yet. So enjoy the party.
Valuation pressures
More concerning is the bond market's reaction to the U.S. election. The S&P 500 SPX trades at a forward P/E of about 22, which is well above its historical average.
The surge in the 10-year U.S. Treasury BX:TMUBMUSD10Y yield after Donald Trump's victory will undoubtedly add to valuation pressures. In the short term, valuation doesn't matter much, though it is an important determinant of long-term returns.
The key question is how the U.S. Federal Reserve reacts to these market conditions. Not only has the 10-year yield risen by 0.15 percentage points, the 2-year Treasury yield BX:TMUBMUSD02Y, which reflects market expectations of the fed funds terminal rate, rose by 0.8 percentage points. The market currently expects two Fed rate cuts of a quarter-point each this month and next.
Stay tactically bullish
For now, my inner trader is staying tactically bullish. The relative performance of junk bonds (dark solid line) is tracking the new all-time high of the S&P 500.
The positioning unwind will play itself out with traders in the coming days and weeks. It's too early to be taking profits.
Cam Hui writes the investment blog Humble Student of the Markets, where this article first appeared. He is a former equity portfolio manager and sell-side analyst.
More: How Trump's win could shake up taxes, jobs and interest rates - and what that means for your money
Plus: The stock market is expecting more interest-rate cuts than the Fed can give
-Cam Hui
This content was created by MarketWatch, which is operated by Dow Jones & Co. MarketWatch is published independently from Dow Jones Newswires and The Wall Street Journal.