The polling and prognosticating are done. The lawn signs are (mostly) gone. It’s finally over. Of course, I’m talking about the recent election.
Our readers know we spoke about election-related uncertainty and how it affects markets heading into an election. Our data, grounded in historical studies, signaled volatility risk into and potentially after the vote.
We now believe a less cautious stance is warranted due to an unexpected level of certainty coming out of last week's election.
Here's why many were surprised: there was a popular expectation that the outcome would be undecided until a week or more after the election.
The fact that there was certainty overnight following Election Day was unexpected and the driving force behind a significant risk-on transition for investors the day after the election. To be clear, in our opinion, this wasn't a reflection on who won, but rather a reaction to unexpected certainty one way or the other being priced in earlier than anticipated.
This created bullish action for equities in the medium and long term. In fact, the day after the election saw some of the most risk-on action in recent history:
“Big money” investor buying hit one of the highest levels in the last year. 481 equities were accumulated in an outsized manner which was the 5th highest buy day since 2009. Prior to last Wednesday we’ve only had 25 days with 300+ buy signals.
The action was similar with exchange-traded funds:
Let’s turn to MAPsignals’ trusty Big Money Index (BMI), which is a 25-day moving average of “big money” investor buys and sells. The post-election buying was so aggressive that it immediately created a bottom put in the BMI (green circle below):
The buying action focused on the growth areas, like small- and mid-cap stocks:
Another reflection of the risk-on market reaction is the S&P Small-Cap 600* rallied to its highest close ever at 1,511.13:
This is an immediate upgrade for small- and mid-cap equities.
We’ve seen this behavior before (more on that later), but not to this extreme. And again, the reason for that is the narrative literally shifted overnight. The newfound certainty was so unexpected it caused an explosion that the market never could have priced in.
When combined with another 25-basis-point interest rate cut from the Federal Reserve last week, this is powerful combination for your equity portfolio.
Don't get thrown off by the fact that the 10-year Treasury jumped last week after the election too:
That increase was an anomaly driven by the unexpected speed of the rotation from selling in fixed income and reallocating to risk-on assets.
People may point to higher mortgage rates as a counterargument. We posit that was an abnormality because there was an unexpected need to tell safe assets and rotate them into risk-on assets. When you sell that much fixed income all at once, interest rates will immediately increase through the market action, not because of Fed expectations.
Furthermore, there are some other historically anecdotal reasons to now bet on risk-on assets, especially small- and mid-caps, due to the election results. Keep in mind that as of this writing we don't have the House final results. But if there is to be a Republican sweep, that’s the best S&P 500# market scenario for a Republican president going back to 1945:
Let’s focus purely on data here, not on the “who.” The reasoning for that level of performance for a Republican president is it creates a scenario that is typically friendly for business growth. That means tax cuts, deregulation, and increased mergers and acquisitions.
For instance, the day after the election, the share prices of Discover and Capital One both shot higher:
Why? Well, a potential merger of the two is currently under regulatory scrutiny. But shares rose because investors think that scrutiny will disappear when there’s an administration less focused on regulation.
Thus, it seems some corporate, pro-growth policies are now being baked in by the market as cyclical areas boom. With this information, it shouldn't be surprising what is working right away. We have historical context looking back at 2016 where strong patterns emerged.
For example, the returns for four major equities benchmarks after the 2016 election show clear outperformance for the S&P Small-Cap 600 and S&P MidCap 400^ early on:
The favoritism of small- and mid-caps lasted for about three months. If you recall, the buys by market capitalization chart above shows heavy activity in smaller stocks. So, the smaller-stock trade is being priced in by the market furiously due to the new, unexpected certainty.
Add in the historical seasonal strength of November and December (below), and our strength-into-year-end thesis seems to have an even stronger foundation today than it did a couple weeks ago.
It’s almost certain we’ll blow past our S&P 500 target of 6,000 (perhaps even when this is published), with the potential for an additional 5%-10% by the end of the year:
It can’t be said enough that the market shifted course swiftly because of the unexpected certainty that came out of the election. It’s the whole reason for this post. We simply can't ignore what took place purely from a market standpoint – and neither should you.
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*Past performance does not guarantee future results.
* The S&P Small-Cap 600 is an index that tracks a broad range of small-sized companies meeting liquidity and stability requirements, like public float, market capitalization, and financial viability, among other factors.
# The S&P 500 is an unmanaged index of 500 widely held stocks that is generally considered representative of the U.S. stock market.
^ The S&P MidCap 400 tracks 400 companies that broadly represent companies with midrange market capitalization.
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