(Bloomberg) — Investors have a challenge betting on the usual stock market rally that usually follows a presidential election: With the S&P 500 Index on track for one of its best starts ever in a year, history can’t guide this time.
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Buying US stocks until the end of the year after a vote is classic trading book. Historically, the S&P 500 has returned an average of 5% from Election Day in November through the end of the year, according to data compiled by Deutsche Bank AG. Even the riskiest sectors, such as small-cap companies, typically get a bid when the tide rises.
But this is certainly not a classic election year. The S&P 500 is up 25% in 2024 after rising 24% in 2023, putting the index on track for the first consecutive years of more than 20% gains since the late 1990s. As a result, stock prices are high: the S&P 500 is trading at more than 22 times forward 12-month earnings, compared to an average of 18 over the past decade. And positioning data shows that traders are already heavily invested in stocks.
Meanwhile, familiar enemies of recent years, rising bond yields and the threat of continued inflation, loom in the background. All of this has the stock market primed for a potentially quiet holiday season — a far cry from the frenzy of recent election years.
“Now that valuations have risen and the S&P 500 is already close to 6,000, the market will continue to rise from here,” said Eric Beiley, executive director of asset management at Steward Partners. “But I don’t foresee a big rally at the end of the year as rising interest rates will keep investors at bay.”
No rush
The Federal Reserve has cut interest rates twice since September. But recently central bankers indicated they are in no hurry to move forward.
At the same time, U.S. Treasury yields have risen to their highest level in several months after U.S. President Donald Trump’s election victory raised hopes that his economic plans, such as high tariffs and mass deportations of low-wage undocumented workers, could fuel inflation and could harm growth. The Fed’s options to cut rates are shrinking. This explains why Wall Street strategists have dialed back their expectations for rate cuts since Trump’s election victory.
The six months from November to April are historically the best part of the year for U.S. stocks, as companies and pension funds tend to increase their stock purchases starting Nov. 1, according to the Stock Trader’s Almanac. However, these year-end rallies are typically not as robust when the S&P 500 is already up at least 20%. In that case, the average return from now until December 31 since the 1970s has been about 1%, according to data compiled by Bloomberg.
Of course, this bull market rally has gone well beyond these levels, with the S&P 500 up nearly 70% since its October 2022 low. That will dampen gains through the end of December, said Savita Subramanian, head of US Equity and Quantitative Strategy at Bank of America Corp.
“Sentiment and positioning across at least five indicators have turned dangerously bullish, leaving less room for positive surprises,” she wrote in a Nov. 15 note to clients.
Heavy cover
Some of the riskiest parts of the market are already showing signs of weakness. Small-cap stocks, for example, have erased most of their post-election rally as concerns about the Fed’s rate path grow. And uncertainty about higher financing costs is pushing investors to hedge against sharp declines. Demand for well-out-of-the-money put options on the S&P 500, the tech-heavy Nasdaq 100 Index and the small-cap Russell 2000 Index has risen to levels last seen during heavy pre-election volatility, according to Kevin Brocks from 22V Research.
That said, the rally is not necessarily in jeopardy simply because there is increasing speculation that the market has gone too far. Valuations and investor sentiment could remain frothy for weeks – even months – before stocks suffer a significant decline, said Max Kettner, chief multi-asset strategist at HSBC Bank Plc. already preloaded.”
Investors continue to pour money into stocks, pouring $16.4 billion into U.S. stocks in the week through Nov. 20, marking the seventh consecutive weekly inflow, according to a Bank of America note citing EPFR Global data.
The optimism is not entirely surprising. Looking at history, the S&P 500’s advance in the past two years is not even half of the average gain of 143% in the 16 previous bull runs since 1945, according to Birinyi Associates.
What investors most want to see as they assess the strength of the rally is for the gains to extend beyond the mega-cap tech that has driven the indexes higher thanks to enthusiasm for artificial intelligence. It’s starting to happen, as the S&P 500 Equal Weight Index has outperformed the regular market-cap-weighted version of the benchmark since Election Day, with financial, energy and consumer discretionary stocks leading the way.
Ultimately, however, it may be the bond market that sends the loudest signal for stock prices. If Treasury yields remain high and the Fed remains firm, there are serious risks in betting on significant further gains in stocks.
“A broader rally is crucial, but the only thing standing in the way of a strong advance for equities for the rest of the year is the bond market,” said Jamie Cox, managing partner at Harris Financial Group. “That could ultimately put an end to a major end-of-year rally.”
–With help from Natalia Kniazhevich.
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