Post-Budget and US election – is it time to invest again?

Many investors have spent the past few months fretting over two high-profile events – the US Presidential Election and the UK Autumn Budget.

Some of them may have even cashed in investments to reduce their risk until these set piece moments have passed.

Now that both have happened, where do investors stand – and what are the prospects for those weighing up whether to invest more of their money again?

US Election - a win for the ‘Trump trade’?

The decisive victory of Donald Trump in the US Presidential Election means that some questions about the future economic policy of the world’s largest economy have now been answered.

Trump has promised to ‘end inflation’ and cut taxes, reduce immigration and impose tariffs on imported goods such as Chinese electric cars. His ability to achieve those things is still to be tested, but markets have wasted no time in forming a view on what they think will happen.

Specifically, markets are pricing in higher inflation (despite what the incoming President hopes) which would probably mean interest rates staying higher than they would otherwise have been. This has knock-on effects for the dollar, which strengthened sharply after his victory, and gold, which fell because the metal produces no income and therefore becomes less attractive if rates are higher. It also knocked bond prices.

You might expect those effects to also be negative for stock markets but Trump’s track record of cutting company tax helped bring about a strong bounce in shares after his win was confirmed.  The S&P 500 jumped 2.5% while the Russell 2000 Index of smaller US companies jumped almost 6%. That reflects the hope that Trump trade policies will privilege domestic US companies.

Clearly, investors are betting on a Trump presidency being good for the stock market. The problem for those sat on the sidelines until the election played out is that the immediate bounce has now happened, and they missed it.

So what are the longer term prospects from investing now?

History suggests politics matters little

Despite the big movements since the election result, a look at history suggests markets don’t particularly care which party holds power. The charts below encompass returns from each US Presidential term going back to 1933. They show that returns under Republican and Democrat presidents have been remarkably similar.

The best returns have come when the branches of government – the White House, House of Representatives and Senate – are divided between the parties. We don’t yet know if that’s the result of the 2024 election, although returns under the other possible result – a Republican sweep of all branches – are only marginally lower.

Data excludes 2001 to 2002 due to Senator Jeffords changing parties in 2001. Calendar year performance from 1933 through 2022. Source: Strategas Research Partners, as of  5 November 2023.

On the basis of that, it makes sense for investors to look elsewhere for clues to the future performance of markets.

Tune out of short-term noise and in to long-term measures

No one knows for sure what will happen in the future – investments can go down as well as up – but investors can make judgements about the strength of the fundamentals that underpin markets. That means looking at valuations and the earnings prospects for companies.

Analysts at Goldman Sachs did this recently looking specifically at the US market, which is not the whole stock market universe, of course, but by far the biggest component of it. They concluded that the US market could have further to go in the near term, with a target level for the S&P 500 index of 6,300 in 12 months’ time, some 7% above its level today.¹

However, they then forecast that returns would begin to level out with the annualised rate of return over the next 10 years amounting to just 3%.

What’s holding the market back, they said, is its current high valuation – around 30 times price-to-earnings – and the fact that a lot of the value and returns have come from a concentrated group of very large companies.

That’s backed up in separate research by asset manager Schroders. It showed that the US market is priced at around 35 times its cyclically-adjusted earnings, or CAPE. (This is a metric which uses longer-term data to produce a more stable valuation). That is 39% above its 15-year average.²

Moreover, the Schroders analysis showed that the fact so much of the US market is concentrated in a small number of very large companies – those ‘Magnificent 7’ tech stocks – holds risks for investors. Specifically, it showed that there have only been eight instances in the past 20 years of US companies featuring in the top 10 performers in consecutive years, meaning the companies that have driven returns this year are statistically unlikely to do so again next year. 

Taken together, these factors make the case that relying on the same companies and the same region to drive returns is unlikely to work. But does that mean investors can’t find other pockets of performance?

The search for value

While the US market, and the biggest companies in it, have been driven to high valuations, other regions and sectors look more reasonably priced.

While US companies have a CAPE ratio of around 35 times, the rest of the world looks much more reasonably priced, as seen in the table below.

Source: Schroders Equity Lens – October 2024 

That’s no guarantee that these alternative regions will perform better, only that there is more room for growth away from America, based on valuations.

For those wondering whether to commit more money to stock markets now, the outlook is mixed. There’s always potential reasons not to invest if you look for them. Valuations on the biggest companies in the biggest market – which have accounted for a lot of the stock market’s recent gains – look stretched.

However, other regions and smaller companies are more reasonably priced. Those investing on a value basis would look to skew away from the US, and within the US to smaller companies.

What about tax? Budget aftermath

The other event making investors uneasy has been the UK’s Autumn Budget, and the threats of a tax-grab from savers and investors.

As it turned out those fears were mostly unfounded. There was no reform of Pensions Tax Relief or the tax-free cash available from pensions. A rumoured rise in Capital Gains Tax (CGT) did arrive but was less severe than some feared. Some had forecast CGT could rise to the same rate as Income Tax but instead gains on investments for higher-rate taxpayers rose by much less, from 20% to 24% – the existing rate for investment property gains.

The one headache for investors – for those wealthy enough to be impacted – was the plan to include pensions within the scope of Inheritance Tax (IHT). This change is not scheduled until 2027 but could alter the retirement income plans of those affected because they will no longer be able to preserve pension savings knowing they can be passed on without IHT applying.

• Watch our Autumn Budget key takeaways

Source:

¹ Goldman Sachs - 25 October 2024
^2,3 Schroders Equity Lens - October 2024